Full Text: Unofficial Transcript Of W&M Hearing On Tax Reform, States And Localities, And Tax-Exempts.

Witnesses emphasized that tax reform should leave the states with as much flexibility in tax policy as possible and retain the charitable contributions deduction, according to an unofficial transcript of a May 1 House Ways and Means Committee hearing on tax reform and its potential effect on state and local governments and tax-exempt organizations.

Multistate Tax Commission Executive Director Dan R. Bucks predicted that because of the intergovernmental issues involved in federal tax reform, the impact on state and local governments "will likely prove to be one of the two or three most important issues of all in federal tax restructuring." He and Harley T. Duncan, Federation of Tax Administrators executive director, called for the creation of a joint congressional-state staff working group to evaluate the impact of any plan that replaces the federal income tax.

The charitable deduction, which would be eliminated in many tax reform plans, is vital to the continued financial health of charities, according to the witnesses from the nonprofit community. They also raised issues concerning the future of tax-exempt bonds, the continued exemption of nonprofits, the effect of elimination of estate and gift taxation on charitable bequests, and proposed taxation of nonprofits' products or services under the National Retail Sales Tax.

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PROCEEDINGS

Ways and Means -- May 1, 1996

[1] CHAIR ARCHER: The committee will come to order. The chair apologizes to our witnesses for being ten minutes late in beginning this hearing.

[2] Today we continue our series of hearings on the issues raised by proposals to replace the federal income tax. Last week we heard from small businesses. Today we will hear from state and local government representatives and from tax exempt organizations.

[3] The view of state and local governments are really very important. Fundamental changes in our tax system may have significant impacts on state and local tax systems' financing and activities. We need and we want state and local government input and expertise as we go about examining the various alternatives for replacing our outdated and counterproductive federal tax system.

[4] We also must consider the impact of fundamental tax reform on tax exempt organizations. In particular, on charities who do so much good for so many. We must consider whether and how current tax exempt organizations should, under a new tax system, be exempt from tax on their activities. We must also decide whether and how there should be tax incentives for charitable giving within the new tax system.

[5] Certainly I think none of today's witnesses would argue that we should keep all of the worse aspects of our current tax system. In fact I'll just digress momentarily to say so far no one has appeared at that witness table nor up here in the chair of a member to defend the current tax system. We shouldn't keep the worse aspects, including the income tax and the estate tax, merely because those taxes allow a deduction for charitable gifts.

[6] Moreover, any reexamination of tax incentives for charitable giving should include consideration of whether current tax incentives are appropriately targeted and whether organizations receiving charitable contributions are devoting a large enough share of those contributions to charitable purposes.

[7] Accordingly, I look forward to and welcome the testimony of today's witnesses and the continued input of state and local governments and tax exempt organizations as we go about this process.

[8] Without objection, members -- Mr. Hancock is recognized for a statement.

[9] MR. HANCOCK: Thank you, Mr. Chairman. I just want to welcome the committee -- or this group that's speaking to us -- to this committee. I specifically want to welcome my friend, Bob Holden, who's the treasurer from the state of Missouri.

[10] There are some questions that I would like to ask Mr. Holden that have nothing to do with the situation here at the federal level, but at the state level, but I will defer on those for private conversation.

[11] Thank you very much. Mr. Holden has represented the state of Missouri for -- although this is his first term he's done what I consider a good job for the state of Missouri.

[12] Thank you very much, Mr. Chairman.

[13] CHAIR ARCHER: The chair would like to ask each witness subsequent to their being recognized to identify themselves and the entity that they represent.

[14] The chair recognizes Mr. Portman to introduce the first witness.

[15] MR. PORTMAN: Thank you, Mr. Chairman. It's my pleasure to introduce a fellow Cincinnatian, Ken Blackwell, treasurer of the state of Ohio.

[16] I have no -- Ken -- other than federal issues to raise with you, you'll be glad to know, since I tend to agree with Ken about a hundred percent.

[17] He brings, Mr. Chairman, a rich and varied background to this important discussion on tax reform. A former mayor of Cincinatti, member of the City Council in Cincinatti, former US Ambassador to the United Nations Human Rights Commission, currently treasurer of the state of Ohio, but also importantly was one of the - - I think -- two state elected officials who was on the so-called Kemp Commission, the Tax Reform Commission, which issued its report earlier this year.

[18] So, it's a pleasure to have you Ken before the committee. I look forward to your testimony.

[19] CHAIR ARCHER: Mr. Blackwell, you're recognized.

[20] MR. BLACKWELL: Thank you, Mr. Chairman.

[21] CHAIR ARCHER: Oh, let me also suggest to the witnesses that we would appreciate it if you would hold your oral testimony to within five minutes; and your entire witness statement, without objection, will be inserted into the record.

[22] Thank you.

[23] MR. BLACKWELL: Thank you, Chairman Archer. Good afternoon to members of the committee and in particular my fellow Cincinatian, Representative Rob Portman, who is a long-time friend and colleague.

[24] For too long, the whole economy -- including the state and local government sector -- has been restrained by a federal tax code that favors one type of state for local taxation over another. This philosophical discrimination runs contrary to the principle of devolution of power to the states.

[25] The current federal tax system also makes state and local governments coconspirators with the federal government in a system that violates the principle of horizontal equity. Horizontal equity says, people of similar economic circumstances should pay similar taxes.

[26] Consider two otherwise identical families making -- both making $75,000 in income; one living in New York and the other in Texas or Florida. The New York family probably pays $4,000 or more in state and local income taxes while the Floridian or Texan pays nothing. Because of federal tax deductibility, the New York family will probably pay close to $1,000 less in federal income taxes.

[27] This unfairly coerces state and local governments into one form of taxation over another. Particularly alarming is the fact that the federal government favors tax policies that often obstruct economic growth.

[28] My service on the Tax Reform Commission made one thing very clear: Real tax reform eliminates the bias against savings and investment. Real tax reform will increase economic growth.

[29] This thesis is supported by empirical data in a recent report by Professor Richard Vedder of Ohio University for the Joint Economic Committee of Congress. He found that, one, relatively low tax states grew nearly one-third faster than high tax states; two, income taxes have a particular adverse impact on income growth; three, federal flat rate income taxes are significantly more favorable to economic growth than progressive taxes; and four, personal income and flat rate taxed states grew about 25 percent faster than did personal income in states with a progressive tax rate structure.

[30] The attached charts to the submitted testimony derived from Professor Vedder's report showed that tax policy impacts state spending and personal income growth. Given this evidence, the federal government's support for pro-consumption, anti-saving tax schemes at the state and local level is clearly anti-growth.

[31] As treasurer of the state of Ohio, my professional interest lies very significantly with municipal bond issuance. Currently state and local issuers enjoy tax-exempt status in the capital markets. Losing this tax exemption frightens some issuers and the average Wall Street investment banker. But the benefits of that change become clear in light of pro-savings tax reform at the federal level.

[32] Increased emphasis on savings and decreased emphasis on consumption will expand capital markets. Increase in savings mean an increase in available capital. As supply of capital outstrips the demand for capital, the cost of capital and the interest rates falls. An increase in savings will also increase demand for savings vehicles: local, state or federal securities.

[33] Again, rising demand for government securities drives down interest rates. The bottom line is that greater economic growth for the people means greater economic stability for the people's government at all levels.

[34] The way to economic growth in this country is obstructed by a high-tech system that punishes savings. Replace that system with one that unleashes the power of the private sector and thereby you strengthen the public sector.

[35] Mr. Chairman, in addition to my remarks I just made, I am submitting an addendum to and an expansion of my remarks for inclusion in the official transcript. Thank you.

[36] CHAIR ARCHER: Thank you, Mr. Blackwell, and thank you for your contribution on the Tax Commission.

[37] The chair recognizes Mr. Crane to introduce our next witness.

[38] MR. CRANE: Well, first of all, I want to express appreciation to all the witnesses for being here today in this important discussion. But, I want to pay a special tribute to the most gorgeous member out there on the dais, Loleta Didrickson, who is our comptroller in the state of Illinois.

[39] Thank you for coming today, Lolita.

[40] MS. DIDRICKSON: Thank you, Congressman.

[41] CHAIR ARCHER: Ms. Didrickson, you are recognized. You may proceed.

[42] MS. DIDRICKSON: Thank you, Mr. Chairman, members of the committee. I am Lolita Didrickson, the Illinois state comptroller.

[43] I am pleased to be here and I am representing the National Association of State Auditors, Comptrollers and Treasurers, NASACT, for the first part of my presentation on behalf of my colleagues in the other individual states. I would like to raise a couple points for consideration.

[44] The various tax reform initiatives that you have under discussion are all of significant interest to the states. They all will, number one, definitely impact state revenues and costs; number two, will definitely impact individual state economies; and the third point is that they will impact administrative efficiency, methods of compliance and enforcement -- possibly the fundamental assumptions, revenue productivity; and taxpayer equity associated with state tax policies and practices.

[45] These impacts will vary in nature and importance state by state. Given the above generalities, there are two messages I really wish to represent on behalf of NASACT.

[46] First, as any of the federal reform initiatives are considered in specific, we really would respectfully suggest that state fiscal officials be provided the opportunity to participate and contribute to the quality and comprehensiveness of the debate. Through NASACT, state fiscal officers such as myself are willing to make that contribution.

[47] A second point that I'd like to make and the final point with regard to NASACT is that at least because of the administrative impacts, if not the economic impacts, states will need time to adjust and implement changes in their own tax policies and practices as a result of any reform measurements that you pass.

[48] Such state government adjustments may need to take the form of amendments to state tax law, revised forms and schedules, taxpayer assistance information and new methods of tax compliance, enforcement and audit.

[49] So the two points here with regard to the NASACT messages: Number one, we really appreciate the opportunity for participation in the policy discussion; and number two, time will be needed to implement any such state adjustments.

[50] I now would like to talk about the Illinois impact with regard to some of the proposals that you're talking about or considering. In specific I'd like to talk about the fact that Illinois is a flat tax state, has been since 1969; and as you are beginning your discussions on comprehensive tax reform -- the federal flat tax proposal that most of us are familiar with with regard to the Armey plan, the tax rate of 20 percent, dropping to 17 percent thereafter, with interest dividends and capital gains exempt and other loopholes closed.

[51] It has appeal because of its simplicity. It doesn't require changes in the Constitution and the current federal graduated income tax. For us in Illinois, it's a loser. Because it really takes our most powerful economic impact dollars out of the state.

[52] Illinois has had that flat income tax rate that I mentioned since 1969. It currently now sits at three percent. We have only three exemptions. The first is retirement income; second is the five percent property income tax credit; and the third is the income tax exemption for the blind and elderly of $1,000.

[53] Now, let me explain our experience with that flat tax system. We see it as having several advantages. Number one, it's broad based, allows us to maintain very low rates and still achieve a productive revenue yield.

[54] Number two, it's simple to enforce and administer. In fact, our EZ 1040 form can actually be in a postcard format.

[55] Number three, it encourages voluntary compliance because it is very easy. Number four, it has -- as Ken Blackwell mentioned -- the horizontal and vertical equity; meaning that taxpayers with comparable, adjusted gross incomes actually are taxed similarly; and finally, the Illinois flat tax rate introduces minimum economic distortions. Actually, taxpayers make the decision for economic reasons, not for tax reasons.

[56] I could go on. There are a couple points that I would like to make, though, with regard to highlights. Finally, I would like to say that we will need to understand what the determining point is for the base for determining the liability at the state level.

[57] For the non-filers who wouldn't have federal liability we would ask you to consider that they would report, also, even though they have no tax liability so that we could run the match against the federal and the state so we can see who would need to be in compliance; and then excluding all unearned income does raise some concerns. There probably are some expected consequences with such a change with regard to higher financing costs for state and local governments.

[58] Finally, I see this as a win-win with regard to any kind of changes you make to make a simpler, flatter, fairer tax code work. We have found in Illinois it does work. We have actually done in the Office of the Comptroller some simple modeling that shows that if you were to pass the talked about, discussed flat tax proposal, that would mean to the state of Illinois about $1.2 billion straight cash to our treasury, if we use a very conservative multiplier based on an assumed $8 billion worth of tax dollars that would be able to stay in our taxpayers' pockets.

[59] Thank you very much for the opportunity to give you the Illinois perspective; but more importantly, the NASACT perspective with regard to our ability to participate; and recognizing the states' need to implement with regard to time.

[60] CHAIR ARCHER: Thank you, Ms. Didrickson.

[61] The chair recognizes Mr. Rangel to welcome and introduce the next witness.

[62] MR. RANGEL: It is my pleasure to introduce the first deputy mayor of the city of New York, which is living proof that you don't have to come from the political arena in order to be an effective public servant as he is. He doesn't come here just politically, but he comes here as a very experienced tax lawyer, who truly understands the value of the contributions made by the great city of New York.

[63] As you know, Mr. Chairman, I don't talk too much about my city, but the fact that it is the cultural center of the world --

[64] (Laughter.)

[65] MR. RANGEL: -- produces raw taxes and all pleasure to entire communities, the Trade Center and financial district, I think we're honored to have someone who understands it, not only politically, but certainly from a tax perspective.

[66] I welcome him in joining this panel and we anxiously await hearing your testimony.

[67] MR. POWERS: Thank you very much.

[68] CHAIR ARCHER: Mr. Powers, you may proceed.

[69] MR. POWERS: Thank you, Mr. Chairman and thank you very much, Congressman Rangel.

[70] As the congressman mentioned, I am a CPA and a tax lawyer. I spent 25 years of my career before entering government practicing tax law. Believe me, there's nobody in this room more in favor of reform of the federal tax laws than myself. I have seen too many times where the tail wagged the dog, where a tax law was so complex that business deals that should have gone on in a very sensible way got reconstructed, redone and were done in a very unsensible way because of the tax laws.

[71] So, I'm very much in favor of any kind of substantive reform, as is the mayor, on behalf of the city of New York. But we've got to be careful when we do reform. We don't want to throw out the baby with the bath water.

[72] New York City has the fourth largest budget in the country, counting the federal government's budget. It's the federal government, California, New York State, New York City, then the state of Texas. We're a high tech city in a high tech state. We've lowered taxes. The mayor has lowered taxes since he's been there, but we do rely in large part on an income tax, a city income tax as well as a state income tax, to fund the resources that we need to take care of the city.

[73] The fact of the matter is, though -- although people talk about the money that flows to New York City -- the fact of the matter is that New York city sends $9 billion more to the federal government than it gets back, and the state of New York sends about $14 billion more in tax revenue to the federal government than it gets back.

[74] The concern that we have -- if there's an elimination of state and local taxes as a deduction that we're going to take a lot of the businesses that are in New York and a lot of the people who live there and they're going to leave, because it's going to become that much more expensive. Under the current rates -- if we took away the state and local tax deduction -- it would be like a 40 percent increase in our taxes.

[75] When people leave New York, it's not so simple to say they'll go to New Jersey, Westchester or Connecticut, large businesses will leave the country. I have spoken to leaders in the securities industry and they've told me they don't have to be in New York, they don't have to be in America anymore to do their business.

[76] We have a wonderful generator of wealth in the city and state of New York. Before we do something that could really hurt that generator of wealth and cause those businesses to leave the state and the city, and possibly the country, and dissipate in a way that could be harmful to the federal government's fiscal interest as well as the city and state's fiscal interest, I think we should be very careful to analyze the effects and to be sure that we know it's not going to hurt the city.

[77] Also, to be sure that the city's balance of payments doesn't get worse under a new tax system, so we don't wind up sending more than $9 billion a year out of the city to the federal government. We love to help. We love to share, but we need a little - - need to save a little bit for ourselves.

[78] We're very concerned about the disallowance of -- the possible disallowance of the exemption for municipal bond interest. Like many cities in the northeast and many cities throughout the country that are older cities, we have an aging infrastructure. We have in New York City a $4 billion, annual capital budget that we spend. Most of that is on infrastructure repair: bridges, rail, subways.

[79] We get a benefit from being able to have municipal bonds and the lower interest rates that create a lot of jobs; and also creates a lot of ability for our economy to thrive in the city. When the city's economy thrives, it has a great impact on the national economy.

[80] So we would not like to see that happen because we believe that would force us to pay higher interest rates and not enable us to do the repairs to infrastructure that we've had to do in the past.

[81] As far as charitable deductions are concerned, we are extremely concerned that at a time when the federal government is asking cities and states to do more -- and we support that and a lot of the block grant concepts that are out there -- that if you take away the tax benefits for charitable deduction, it could be very harmful and limit charitable deductions.

[82] I have to go back to my experience as a tax lawyer for many years. Many times, charitable deductions happened because of the benefits, the tax benefits, that were there. We could create ways where taxpayers could save a lot of dollars and still give a lot of dollars to charity. Everybody seems to benefit and the federal government didn't have to pay the full cost of the dollars that went to charity.

[83] At a time when we're trying to do things in New York with less government help, such as welfare reform, which we've achieved in New York. We have 125,000 less people on welfare than a year ago. We have the largest workfare program in the country. Today, as we speak, 20,000 people who receive welfare benefits are working for the city of New York. They're helping to clean the city, they're working in offices. We give them the dignity of a job.

[84] At a time like that when we're very often a partner with charities to get benefits to people to help them out of tough situations -- to take away the benefit from charitable deductions we think would be very detrimental. We also employ thousands and thousands of people in the city of New York -- 400,000 -- in one way or another are affiliated with our charitable institutions. They have budgets of over $30 billion that gets spent. A lot of that money is spent, not just in the city of New York, but also nationwide. We think it will be very harmful to us if you did that.

[85] Lastly I might say that certainly we'd like to -- since we want to really make sure that people save money and not consume, we'd like to defend the home interest mortgage deduction. When you think of it, for your average person, the only way they create wealth -- in many people's lives -- is by buying a home and spending the money on the mortgage every month and seeing the value of that home grow.

[86] Also, in the city of New York, home ownership is one of the major housing programs that we're pushing, because we believe that brings back neighborhoods, it gives people a stake in their neighborhoods and also creates a better economy and better jobs for the people when we do that. So we would not like to see that done.

[87] In conclusion I would like to say: We support tax reform. But before we do certain things, we should be very careful that we are not -- as I said earlier -- "throwing the baby out with the bath water," because we have a terrific economic engine in the city of New York that creates a lot of wealth in this country.

[88] I'd hate to see a change in the tax law dissipate that wealth in a way where not only New York loses it, but perhaps the country loses it.

[89] I thank you very much for the opportunity to speak here today, Mr. Chairman.

[90] CHAIR ARCHER: Thank you, Mr. Powers.

[91] Mr. Holden, you have already been welcomed by your representative on this committee, Mr. Hancock. I also welcome you and we'll be pleased to have your testimony.

[92] You may proceed.

[93] MR. HOLDEN: Thank you, Mr. Chairman. Congressman Hancock, my friend from southwest Missouri and members of the committee, I am Bob Holden, the state treasurer from Missouri, and chairman of the legislative committee of the National Association of State Treasurers or NAST.

[94] I have a written statement that I have submitted for the record that's extensive.

[95] As a chief financial officer within our respective states, state treasurers exercise a broad range of essential, fiscal responsibilities, including cash and debt management, investment of public funds and the investment and management of public pension funds.

[96] Because state treasurers recognize the complexities involved in shaping public fiscal policy, NAST appreciates the opportunity to begin what we hope will be an ongoing dialogue about tax reform and tax policy, and its impact on our shared enterprise, the federal, state and local government partnership; and the citizens we jointly serve.

[97] At the outset, let me make clear that NAST is not here to speak against tax reform. To the contrary, the state treasurers share your concerns about the problems, impediments and the inefficiencies in our existing tax structure, and we are here to say that we are eager to work with you to explore ways in which tax reform can provide an overall benefit to the taxpayers and to the economy.

[98] However, we also wish to offer a precautionary message. The operation of federal, state and local government is linked at a fundamental level. We draw our resources from the same taxpayers. Decisions on matters of federal tax policy will flow downstream from Capitol Hill and have a dramatic and widespread effect on state and local fiscal management tax policy choices and the execution of governmental responsibilities.

[99] Care needs to be taken that the pursuit of federal tax reform does not hamper efforts to create a new federalism by impairing state and local sovereignty and increasing our fiscal dependence on federal government. In this regard, I would like to draw your attention to a few areas of state and local fiscal management NAST believes will be serious affected by major federal tax reform.

[100] First, several of the current tax reform proposals would remove the long-standing tax exemption for income generated by bonds issued by state and local government. This unique tax treatment has served to lower the cost of borrowing for state and local governments and has made it feasible to build schools, hospitals, roads, subways, airports and other facilities and infrastructure vital to economic development and the growth in our states and local communities.

[101] While experts may disagree on the economic effects of removing the tax preference for state and local securities, there's no argument that state and local governments face a backlog of infrastructure needs and a shortage of capital.

[102] When you add to this the responsibilities which will flow to the state from Washington under devolution and the new federalism, it is clear that state and local governments will need more, not less capacity to finance government projects and services that will be resting on the shoulders of people in state and local governments in the future.

[103] Accordingly, NAST recommends that Congress exercise great caution when considering any tax reform measure which could potentially jeopardize the ability of state and local governments to access low-cost financing, or which hamstring the flexibility of state and local governments to generate capital investments.

[104] Second, almost all state and local tax systems conform significant portions of our tax law to the existing federal tax program and system. For example, nearly every state with a personal or corporate income tax begins from a federal starting point; and then utilizes numerous other provisions of federal law in the calculation of state tax.

[105] States also rely extensively on federal enforcement and compliance programs, and federal information reporting and withholding mechanisms to facilitate the administration of state tax law. By doing this, states make it easier for taxpayers to comply with state tax laws because taxpayers are not required to deal with two widely different sets of tax laws.

[106] Given this linkage between state tax systems and the existing federal tax system, it is clear that fundamental, federal tax reform will also trigger fundamental changes in state tax policy and law. Federal tax reform will compel the states to choose between continued conformity with the federal law or the creation and maintenance of an independent tax infrastructure.

[107] Moreover, it is also clear that economic, administration, legal and political considerations will put tremendous pressure on the states to remain in conformity with any new federal law, since greater the degree of non-comformity, the more complex and burdensome the state taxes would be for taxpayers and more difficult to enforce.

[108] The principles of federalism and the genuine partnering between federal, state and local governments require a complete analysis of the issues before implementing such a federal constraint on tax policy and choices made by state and local government.

[109] Under the Constitution, a core element of sovereignty is the autonomy to develop a tax policy and design a revenue system which meets the needs and reflects the desires of our taxpayers. Fundamental federal tax reform will force the states to choose between simplicity, continue to conform to federal tax law -- whatever its form -- or autonomy, with all its attendant costs and burdens.

[110] Simplicity will effectively pass control of state tax policy and the ability to generate state revenue to Congress. Autonomy will result in the need to go to state legislators to obtain legal authority to employ a non-federal taxing mechanism which will generate enormous administrative cost and compliance problems, and will challenge the willingness of taxpayers to give state and local governments sufficient tax head room.

[111] If there is to be any real choice in this matter, Congress, state and local governments must work together to fashion changes in tax policy which recognize both the effective reach and the inherent limits of our intergovernmental relationship with the American taxpayer.

[112] Such a dialogue should also include the consideration of potential impact on state and local revenue streams and credit worthiness from proposed changes and the mortgage interest deduction, and the deduction for property taxes and state and local income taxes.

[113] As you can see, the matters I have been discussing are not merely theoretical issues to be debated on college campuses or think tanks in Washington, DC. Federal tax reform raises serious questions involving the fundamental relationship between federal, state and local government. The outcome of this debate will have a significant fiscal impact on every state and in every community in this country.

[114] Most importantly, however, we must not forget that the parties most affected by this debate have a human face. They are the citizens of this country. When you push beyond the constitutional theory and political rhetoric, we are talking about shaping the tax burdens which will be imposed on real people, who are trying to earn a living, feed and care for a family and put a roof over their heads.

[115] As public officials, it is our responsibility to honor this public trust by working together to fashion an intergovernmental tax structure that is not only simple and fair, but it also enhances opportunity and the quality of life for the people who pay the bill, while keeping the tax burden at a minimum.

[116] Accordingly, NAST calls upon the national organizations of state and local officials to join with us in conducting a coordinated, national analysis of the impact of federal tax reform on state and local governments, which can be presented to you and to this committee and to Congress for use in this debate. That's our partnering.

[117] Finally, NAST wants to convey in the strongest terms that whatever decisions you might reach about the specific components of tax reform, it is critical that Congress build in a reasonable transition time for state and local governments to coordinate with any new federal tax provisions.

[118] As we have illustrated today, fundamental federal tax reform will have a significant impact on critical aspects of fiscal operations of state and local government, requiring adjustments in tax policy and revenue systems that management and program priorities. In many cases, changes will have to be made in state law to accommodate such adjustments.

[119] Retooling and intergovernmental tax structure is a project on par with balancing the budget and should not be given short shift.

[120] Mr. Chairman, a famous Missourian, Mark Twain, has been credited with saying: "Everybody complains about the weather, but nobody does anything about it." I think he will be pleased to know that you are doing something about an issue which concerns millions of Americans. It will not be an easy job, but I trust that my remarks today and through remarks of other members on the panel that you can see that NAST and all of us want to work with you to meet the goals of a simpler, fairer and more efficient tax system than we have today.

[121] Thank you very, very much.

[122] CHAIR ARCHER: Thank you, Mr. Holden.

[123] Mr. Dorso, you do not have a member on this committee to warmly welcome you, so, I am pleased to assert myself in that capacity and to tell you we are very, very pleased to have you here.

[124] I suspect that you travelled more miles to get here than the other members of the panel. We'll be pleased to have your testimony and you may proceed if you'll please identify yourself for the record.

[125] MR. DORSO: Thank you, Chairman Archer; and good afternoon members of the committee.

[126] My name is John Dorso. I'm the majority leader of the North Dakota House of Representatives and a member of the executive committee of NCSL.

[127] I'm delighted to be here --

[128] MR. HAYS: Mr. Dorso, could you bring the mike up to your mouth a little closer.

[129] MR. DORSO: By the way, I travelled from Florida. I was on a little vacation.

[130] (Laughter.)

[131] MR. DORSO: Basically I'm here today to bring you the state perspective, a little bit, on tax reform. The four main points that I would like to make on that are these:

[132] We're sympathetic to Congress' desire to reform a federal tax system that is viewed as complicated and unfair; federal and state tax systems are inextricably linked; any federal reform will have serious ramifications on the states; and state legislators must be involved in the process.

[133] Let me illustrate some of my concerns. In North Dakota, we have a citizen legislature. We only meet for 80 days every two years. That's in the constitution in North Dakota. Anything that you would do to change taxes would have a big effect on our state. In fact, I had our legislative council people prepare some drafts and other work for you to peruse later on that I have submitted as part of my testimony.

[134] I think approximately 22 percent of our general fund is generated through personal income taxes and there's some other seven or eight percent that comes from corporate income taxes.

[135] We left the '95 session of the legislature with an $11 million ending fund balance of the $3 billion budget. Any change that you might make in the tax system, as you can see, would have a big effect on the state of North Dakota's budgetary problems. In fact, depending on the timing of it, may cause us to go into a special session, which I can tell you, the people of North Dakota particularly like, nor do our citizen legislatures, most of whom are at home trying to figure out their taxes in April.

[136] I guess my biggest message here -- and after listening to the other members of the panel, who certainly have studied the issue more than I have as far as the intricacies and practical effects on their particular constituencies is that NCSL -- and I'm sure all of the legislative bodies across this country -- really want to be involved in this.

[137] I think as a citizen legislature I'd like to just give you the message that -- and I'll pass on a conversation I had with a member of our legislative council which prepared the other stuffers - - he thinks the federal tax code is a mess. That's a non-partisan statement, because the legislative council is non-partisan, but we really need to do something about it.

[138] North Dakota is really simple in the way we approach income taxes. We charge 14 percent of the federal tax liability. Over the years, many people have introduced measures in the legislature to change things, any number of different deductions, et cetera, and they've all been rejected by the people of North Dakota because people of North Dakota have always relished a simple tax system -- 14.5 percent of the tax liability. You pay accountants a lot to get to your federal tax liability and then you can figure out your state tax liability pretty simply.

[139] So, I think that North Dakotans in general like simple taxes. I don't think that any of us are afraid to pay our taxes, but we sure hate paying accountants to have to figure out how to do it.

[140] I as a businessman just sold a business. I was intrigued by a remark that was made here. I sold my truck line on December 28 and it took two months for my accountants and CPAs to figure out what the best date was to sell the appropriations. I think that's a little silly. I think that's terrible when tax policies drive business decisions like that.

[141] My final remarks, Mr. Chairman. We would like to be part of this process. I think NCSL would like to offer its help in your deliberations. Certainly state legislative bodies have some resources that we could put to work in helping you. We're inextricably tied to what you do. Certainly it has a big effect on our budgets and we'd just like to have our feet under the table as you go forward with this process.

[142] Thank you.

[143] CHAIR ARCHER: My thanks to all of you. You've all made, I think, an outstanding contribution.

[144] Let me assure you that your point we should give adequate time for the states to change their process so that it can fit within whatever we do is well noted. I believe all of us would agree that we must have a commitment to that, regardless of what direction we go. We must be aware that your legislatures only meet at certain times and sometimes only once every two years and it's difficult to call special sessions. I can assure you that we will be very sensitive to that.

[145] I also would say to you that it is not the intention of this body to do anything this year on structural tax reform. But these hearings are very helpful to us in laying the predicate and giving us the kind of input that we need to have so that we can do it in a very thoughtful and not precipitous way.

[146] Because, whatever we do, if it is truly structural replacement of the current income tax; it's going to represent a major change. Major changes should not be taken lightly.

[147] Mr. Dorso, I was pleased to hear you talk about your own personal experiences, because each of us wears two hats in this world. We have certain professional or business entities or associations that we represent. In your case, state governments. But we're also individuals and we have to deal with this income tax as individuals, as well as whatever its impact may be on the entities that we represent. Sometimes that brings a conflict of interest.

[148] I've asked every witness that's come before our committee, if I can, I ask you to put your personal hat on for a second and then we'll get back to the entities you represent. How many of you prepares his or her own income tax?

[149] (No verbal response.)

[150] CHAIR ARCHER: Well, I'm not surprised. There are only a few of us in the Congress who prepare our own income tax. I continue to do it just for the challenge of it and to try to be sure that I have a greater understanding and detail of what this committee is putting on other people.

[151] This year as usual I had to get an extension because it is so complex; and I couldn't get all the information together that I needed to prepare my own income tax.

[152] I'm going to ask you another question I've asked all the witnesses. From a personal standpoint, what would it be worth to you, individually, not to have to file a federal income tax? I'd like each of you to give me your best judgement response on that.

[153] Mr. Dorso?

[154] MR. DORSO: Mr. Chairman, I'll use another personal anecdote I have. I have six children and I own two subchapter S's and I'm involved in some limited partnerships, et cetera, et cetera.

[155] I'll tell you, when you start -- when you have six children who are all involved in family businesses, et cetera -- I didn't do my own personal income taxes, but I tried to help my children with theirs -- are you talking dollars, time or just frustration?

[156] CHAIR ARCHER: No, I'm talking about if you could quantify it as to a monetary value, what would it be worth to you, annually.

[157] MR. DORSO: Well, in my own personal instance, between the two subchapter S corporations that I own with the children and everything I suppose it would cost me -- well, I haven't gotten the bill for this year, but it's going to exceed $7,000.

[158] CHAIR ARCHER: So, you would voluntarily pay $7,000 not to have to deal with the income tax in your personal income tax in your life each year?

[159] MR. DORSO: Replace the income tax with a check for $7,000 I'll be happier than you can imagine.

[160] (Laughter.)

[161] CHAIR ARCHER: Mr. Blackwell?

[162] MR. BLACKWELL: About the same.

[163] CHAIR ARCHER: About the same.

[164] Mr. Holden?

[165] MR. HOLDEN: I've been a public official as a legislator now as a treasurer, so my tax return is not very complicated. But there is a tremendous amount of frustration on the part of the citizentry about the process that they go through.

[166] So, any way we can simply this process I think we should take a serious look at.

[167] CHAIR ARCHER: Ms. Didrickson?

[168] MS. DIDRICKSON: My personal story is going to be my son who is 25 years old and he happens to be a bond trader. He's got great appeal with regard to the simplification of the tax code at the federal level.

[169] He doesn't make that much money. I believe the concept of being able to simplify that and not have to have somebody else preparing it when you're not making a great sum has great appeal. I think it has appeal to the younger generation in a way that maybe none of us are really as aware of.

[170] CHAIR ARCHER: But, could you place -- as far as you personally are concerned -- could you place a value on how much it would be worth to you not to have to deal with the IRS at all in your personal life?

[171] MS. DIDRICKSON: I really can't put a monetary value to that, but it has tremendous appeal.

[172] CHAIR ARCHER: Okay.

[173] Mr. Powers?

[174] MR. POWERS: Mr. Chairman, as long as I work in the government, it's worth a couple thousand dollars. If I go back to the private sector, it will be worth a lot more to me than that.

[175] (Laughter.)

[176] MR. POWERS: I always felt it was disgraceful that people had to spend a lot of money to do a basic, civic duty of paying your taxes. So, it's worth a lot, I think, to a lot of us.

[177] CHAIR ARCHER: I've often believed, too -- or always have believed that it's very difficult to quantify the value of individual liberty and privacy, not to speak of all the administrative red tape and what you have to pay a preparer and everything else.

[178] But the mere fact that there's an entity up here with the enormous power over our lives who can accrue and demand records, can demand that you prove your innocence, even from the standpoint of individual liberty and privacy that's worth something; and it's very hard to quantify.

[179] But, on one panel where I asked this question a lady -- middle income lady from Connecticut, who was a witness -- testified when I got to her: "I would give my first born child not to have to deal" -- she had had some untoward experiences with the IRS. Let me just say that.

[180] But, I think it's interesting to note that, then, let's get back to more basic considerations.

[181] Mr. Powers, let me ask you, what was the experience in New York City when we dropped the maximum marginal rate from 50 percent to 28 percent insofar as the ability to negotiate your tax exempt bonds and any other aspects of that change in the federal law?

[182] MR. POWERS: I have to give my experience as a tax lawyer. I wasn't with the city government at that time.

[183] At a lower rate, they were still favorable. Because people adapted to the lower rate very quickly. They had the sense that this is the highest it ever should be. Even though it was a tremendous reduction in taxes, mostly the high income taxes. The municipal bond business was still good. People were still going to do it.

[184] I think there was a little bit of hesitancy, because the benefit wasn't as good. But from my practice in advising people on how to avoid -- not evade, Mr. Chairman -- avoid paying the maximum amount of taxes, this was still a very important factor for them.

[185] CHAIR ARCHER: Yeah, I think that everyone should understand that the term, "avoidance," is legal. The term "evasion" is illegal.

[186] MR. POWERS: That's right.

[187] CHAIR ARCHER: Would you render an opinion as to what impact it may or may not have on municipal bonds, if the rate were reduced from 28 percent -- well, not 28 today. It's 39.5 percent today, the maximum marginal rate -- if that were reduced to 20 or 21 percent?

[188] MR. POWERS: Well, the benefit you get would be less and I would imagine it would have a negative effect. Although -- believe me, I'm not suggesting that we don't go to 21 percent by my answer on that.

[189] CHAIR ARCHER: Uhm hum.

[190] MR. POWERS: But I'm saying that it's something we have to address to keep that still as exempt income.

[191] I think there would still be a market for it, because people play on the margins and if they could get a better return they would do it.

[192] CHAIR ARCHER: So you think the city of New York would not be disadvantaged by that as far as the interest rate on the municipal bonds?

[193] MR. POWERS: Not if the federal tax rates went down, if that's how it happened. I don't believe we'd be terribly disadvantaged. There may be some fall out, but I don't think a lot.

[194] CHAIR ARCHER: You, I think, mentioned the home mortgage interest as a deduction, too. That deduction would be worth less at 20 or 21 percent than it is at 39.5 percent. Would you be concerned about that?

[195] MR. POWERS: Yes, I would. Because, I think -- when you look at your home buyers, especially the young home buyers, those percentages in pennies and dollars mean a lot, mean whether they can buy that house or not buy that house very often, especially with the younger people. Perhaps more so an effect on them than many people who buy municipal bonds who are dealing with wealth they've accumulated and bought the bonds.

[196] I would be very concerned about that because having represented many homeowners in purchasing their homes, the first home, as a practicing attorney; a lot of them are really tight. People tend to stretch a little bit. Homes are expensive in my area and I think it could have a very negative effect, not only on people purchasing homes; but in the long run, as I mentioned when I spoke, if they don't buy the homes, they're not going to accumulate the wealth.

[197] This wealth gets recycled. This is wealth when they sell those homes that gets invested over the years. So, that's the negative effect I see happening.

[198] CHAIR ARCHER: If the deduction were retained but the rate was 20 percent instead of 39.5 percent so that the deduction were not worth as much, would you see that as a problem?

[199] MR. POWERS: No.

[200] CHAIR ARCHER: Mr. Rangel.

[201] MR. RANGEL: Mr. Powers, would you agree that whether or not this -- the green light just went on. Did you notice that? Because it wasn't on when you were questioning.

[202] (Laughter.)

[203] MR. RANGEL: Well, do you know -- would you believe that whether or not we pull this tax system up by its roots or whether or not we are sensitive to the deduction of local and state taxes may well depend on the outcome of the congressional election next November?

[204] MR. POWERS: Oh, Mr. Rangel, you correctly said, I didn't come from politics, so I can't --

[205] MR. RANGEL: Let me just based on the fact that -- you think it could have an impact?

[206] MR. POWERS: Well, I'm not sure I understand the question.

[207] Certainly, congressional elections depend on who wins, who loses and how they feel on these things.

[208] MR. RANGEL: Very good. We'll discuss it with the mayor before the elections come up.

[209] Mr. Blackwell, I know clearly what you're against. What type of revenue system do you have in the state of Ohio? How do you raise your taxes?

[210] MR. BLACKWELL: We have an income tax and we have a sales tax. The income tax is a progressive tax rate system, which in fact - -

[211] MR. RANGEL: Do you oppose --

[212] MR. BLACKWELL: -- is five rates --

[213] MR. RANGEL: I'm sorry.

[214] MR. BLACKWELL: Which is five rates too many.

[215] MR. RANGEL: If we wiped out the income tax system, that would wipe it out for Ohio, too. Would it not?

[216] MR. BLACKWELL: It would. It would change -- the transition period that we would have would be scrambling for a definition of "what is income?" since it in effect would do away with the income tax system, you'd have to have another initiative; but that would put us on even footing with all the other states.

[217] I'm sure that a state that has put a now Senator on the moon could figure out how to adjust to that situation.

[218] MR. RANGEL: You stated that you were advocating the wiping of the federal income tax system toward a flat tax that would be pro- savings and anti-consumption.

[219] MR. BLACKWELL: That's not what I said. I think if you listen to all the panelists, particularly the gentleman from New York, going to a single rate tax system does not in fact do away with the income tax system of the federal government. It takes it from a progressive, multi-rate system to a single rate system, but it is still income based.

[220] MR. RANGEL: You will then support an income based flat tax, federal flat tax?

[221] MR. BLACKWELL: A single rate system.

[222] MR. RANGEL: Then you would pay back your state -- you would support a flat tax for your state as well?

[223] MR. BLACKWELL: Absolutely.

[224] MR. RANGEL: And you would advocate the preservation of the exemption or the deductibility of the mortgage interest?

[225] MR. BLACKWELL: Right, I would.

[226] MR. RANGEL: And, would you support the deductibility of charitable contributions?

[227] MR. BLACKWELL: I would.

[228] MR. RANGEL: Are there any other deductions that you would support in this flat tax?

[229] MR. BLACKWELL: Yeah, I would -- you have named two and the other one that I would add on the -- put on the table is the poor deductibility for workers in this country of the payroll tax, since employers can, in fact, write it off as a cost of doing business, I think the workers of America, and particularly in the state of Ohio, should have the full deductibility of that very, very regressive tax.

[230] More young people in my state pay more in the payroll tax than they do in the income tax. So, I --

[231] MR. RANGEL: So you would say --

[232] MR. BLACKWELL: -- think this opportunity that Congress has to radically change the entire tax system is very, very beneficial.

[233] MR. RANGEL: This contribution to the Social Security Pension Fund and the contributions to health care, you really believe should be written off?

[234] MR. BLACKWELL: My belief is that, if you look at the demographics, Representative Rangel --

[235] MR. RANGEL: I'm not arguing with you. But, you believe --

[236] MR. BLACKWELL: What I'm saying is, if you look at the demographics, we are going to the people of this country to tell them that in 30 years --

[237] MR. RANGEL: Mr. Blackwell, I am agreeing with you.

[238] MR. BLACKWELL: Okay, but --

[239] MR. RANGEL: I'm agreeing with you, it's a regressive tax. I'm just trying to make it clear that you would want a deductible. Because by the time I get finished with these deductibles, this flat tax ain't gonna be that flat. That's all.

[240] So, I'm agreeing with you about the impact.

[241] MR. BLACKWELL: You hit my three deductibles.

[242] MR. RANGEL: Okay, you are opposed -- if a person -- do you have a city tax at all?

[243] MR. BLACKWELL: In chartered cities. Some of our chartered cities have city taxes.

[244] MR. RANGEL: What?

[245] MR. BLACKWELL: Some of our chartered cities have city --

[246] MR. RANGEL: In those chartered cities, would you support allowing the citizens of the chartered cities to deduct their city tax from the state tax; or they would have to pay the city and the state tax?

[247] MR. BLACKWELL: Mr. Rangel, I believe that taxes are the prices we pay for government services. I believe in the principles --

[248] MR. RANGEL: I believe in all that you believe in Mr. Blackwell. I'm just asking you whether or not the taxpayer -- I'm in for simplicity, you see.

[249] MR. BLACKWELL: I am --

[250] MR. RANGEL: I agree with all those principles. It's just that, when they put those lights on for me it means I can't talk anymore.

[251] MR. BLACKWELL: I'm simply delighted to be here to --

[252] MR. RANGEL: We'll meet again. But, my time has expired; but you and I are for good government, simplicity of taxes and deductibility where it's favorable to our constituency.

[253] MR. BLACKWELL: No, I am for what I think is in the interest of the American taxpayer. I'm not here telling you that if it's good for the Ohio taxpayer and not good for the American taxpayer -- since Ohioans are Americans also, Mr. Rangel -- that I would argue the narrow interest.

[254] I think that what we have to do is deal -- to deal with a tax system that is strangling economic growth that's the primary source of economic anxiety that the President and members of this Congress talk about, that is driven by two tracks: One, income stagnation and the loss of -- the sense of job insecurity.

[255] The only way we're going to get the economy going again is to in fact unshackle it from a federal tax system that is complicatory [sic], anti-growth, anti-savings and anti-investment; and --

[256] MR. RANGEL: And anti-education, anti-training and anti- jobs and has more people in jail than most civilized countries. That has some impact, too, wouldn't it, Mr. Blackwell?

[257] What? Would that have some impact? The fact that we have more money invested in our jails than our educational system.

[258] MR. BLACKWELL: What I'm saying, Mr. Rangel, is that I think that we should, in fact, unleash the American economy, create jobs, lift incomes and one of the ways in which you can do it is, in fact, by simplifying the system that is suffocating in its complexity.

[259] MR. RANGEL: I'm agreeing with you.

[260] CHAIR ARCHER: The gentleman's --

[261] MR. RANGEL: It's just that you don't want to agree with me.

[262] MR. BLACKWELL: It's a love fest.

[263] CHAIR ARCHER: The gentlemen are in agreement. The gentleman's time has expired.

[264] Mr. Crane.

[265] MR. CRANE: Thank you, Mr. Chairman.

[266] Loleta, the flat tax we introduced in Illinois started the same year I came to Congress and I've been a champion of a flat tax all the years I've been here. I'm in competition with my distinguished chairman here, who --

[267] MS. DIDRICKSON: I'm aware.

[268] MR. CRANE: Who wants to root the IRS out with a consumption tax and I pointed out to him that he has some validity in his arguments since we went from 2.5 percent to three percent. Bill's concern, of course, is when you create a flat tax subsequent Congresses can continue to ratchet it up.

[269] However, we do have a consumption tax along with our flat tax in Illinois. I was just explaining to him the worrisome thing about a consumption tax from my perspective is that people are not as painfully aware of what they're paying in taxes when you've got a consumption tax as they are when they have to submit their payment based on their earnings.

[270] I think we have a demonstration of that, in part, in the state of Illinois since our consumption tax is five percent and our flat tax is only three percent. Be that as it may -- and I'm still open to further input from my distinguished chairman.

[271] CHAIR ARCHER: If the gentleman will yield. I did not intend to get into a debate, a flat tax and the consumption tax debate. We will get into that at a later time.

[272] MR. CRANE: Sounds good.

[273] But the fact of the matter is, in terms of the issue that Loleta brought up here is that on the differential one you exclude unearned income. The differential you have then in trying to offer attractive tax exempt municipals or tax exempt state bonds -- the same principle would apply with regard to imposing a consumption tax.

[274] It's something that raises a valid question to me in part except, since those authorities with the power to tax would not in offering a municipal bond or state bond still be more attractive at the identical rates that the private sector is offering -- would that not be more attractive an investment because of the fact that they have that endless power to tax and raise the revenues to cover their outstanding liabilities.

[275] This, to be sure, would increase costs at the local and the state level. But, it's always struck me as kind of unfair that with those advantages in an open market that whether it's a local municipality or a state that they have that advantage of the tax exempt status to the bonds they issue. Wouldn't it be a fairer, level playing field if everybody's playing on the same terms?

[276] MS. DIDRICKSON: We had that discussion in the Office of the Comptroller and I'll limit my comments to the Office of the Comptroller. In fact, there are many of us who believe that that would be a level playing field and that there is an attractiveness to that discussion. But it also is recognized that it can increase costs with regard to going to the markets for capital projects.

[277] You're absolutely correct, Congressman. With regard to the consumption tax in the state of Illinois, too, I'd like to briefly comment on that.

[278] We do have the five percent consumption tax, but we have been very careful in the Illinois General Assembly and the Executive Branch to not over-burden it, because it is a regressive tax; and that discussion and debate goes on repeatedly in the Illinois General Assembly.

[279] Getting back up to our flat tax that you were talking about, indeed we have raised it. But it has been a half percent since 1969. We've been very careful so it has still remained a very broad, a very low tax which has had a high yield with regard to revenue.

[280] MR. CRANE: Well, I thank you all again for your testimony; and I appreciate your input.

[281] Loleta, I look forward to working with you back home.

[282] MS. DIDRICKSON: Thank you, Congressman.

[283] MR. CRANE: Thank you all.

[284] MS. DIDRICKSON: And, thank you, Mr. Chairman.

[285] CHAIR ARCHER: Mr. Portman.

[286] MR. PORTMAN: First, I thought Mr. Blackwell did a good job in the Ohio versus New York debate earlier with my friend, Mr. Rangel, but I want to give him a chance to talk about one of the issues where I think he may differ with some of the other panelists. That's in the area of tax exempt bonds.

[287] I guess my question would be to Mr. Blackwell and then perhaps Mr. Powers or another panelist might want to chime in. What would the effect be, in your view, of a flat tax on -- let's say the flat tax proposed by the Kemp Commission -- on tax exempt municipal bonds? What would be the effect on the market?

[288] MR. BLACKWELL: Thank you, Mr. Portman.

[289] Tax restructuring, in my opinion, will not take away any of the advantages enjoyed by municipal bonds, nor will it raise borrowing costs for state and local governments. Indeed, by strengthening the economies of the state and local governments, I think revenues will be increased and there will be a reduction in the need for welfare related outlays.

[290] In particular, tax exempt securities will not fall in price. This concern is based on a misunderstanding of the relationship between taxable and non-taxable securities and the functioning of the credit markets. I think it's without merit.

[291] Interest rates consist of a basic rate of return demanded by lenders, plus premiums reflecting differences in risks among the various securities, plus expected inflation and taxes. Tax exempt bonds do not have a premium, taxable bonds do.

[292] Under the single rate system envisioned by the Commission, the tax premium in currently taxable bonds would fall to the current tax exempt rate or levels. I think that will result in no significant change in the tax treatment of tax exempt bonds. Their prices and interest rates would be largely unchanged.

[293] MR. PORTMAN: Mr. Powers, do you have a comment?

[294] MR. POWERS: Yes, Mr. Portman. I think the key here is to keep the tax exempt bonds. Tax exempt bonds have lived through 70 percent tax rates back at one point, where we had that on unearned income; 50 percent tax rates; 28 percent tax rates; and they've thrived.

[295] The question is -- you know, some of the thought is to really take away the exemption. That I think is dangerous. I think the market will adjust to different tax rates.

[296] Although we're talking one tax rate, over the years tax rates have changed. I think the key here is to give some benefit to municipalities so they can get a lower cost of funding, especially at a time when they have a fixed infrastructure and Congress is giving less money.

[297] MR. PORTMAN: In effect, I think part of what Mr. Blackwell is saying is that economic impact of a flat tax and all the efficiencies you get with that would have benefits that would supercede some of the detriments that you might see to municipalities not having that tax status. How do you answer that?

[298] MR. POWERS: I'm not sure of that; and I'd have to say flat tax is a very broad term as we're talking here. I'm not sure what the benefits would be that would offset that. We rely very heavily on that in spending $4 billion a year and it would have a big impact on New York if the cost went up.

[299] MR. HOLDEN: Congressman, nobody knows the answer to your question. I mean, I could bring you up studies that would give you every point of view on that issue.

[300] What I would hope this committee would keep in mind is that at a time when more and more responsibility is coming back to the state and local governmental entities through handling public policy issues, is also the same time we've got to focus more of our efforts on infrastructure, on roads, highways and bridges.

[301] This, by an large, has worked pretty well at the state and local level up through the years. Any changes you want to make, I would hope you would look at them very carefully and look at the long-term impact of what is being discussed before we dramatically changed or removed the tax exemption for state and local bonds.

[302] MR. PORTMAN: Unbelieveably, I have the light also. I thought the light was just for Democrats, but it's also for Republicans.

[303] (Laughter.)

[304] MR. PORTMAN: I think we have time for maybe one more comment.

[305] Mr. Dorso?

[306] MR. DORSO: Congressman, I've heard the experts here. I'm just giving my citizen's bent. I think interest rates drive decisions about buying houses more than taxes. I have children who are in the process of buying houses and a two percent swing in the interest rate is going to make a heck of a lot more difference than what you do in taxes.

[307] I think the bottom line is with municipal and state bonds it's the same thing. I don't know how far you can go and I don't know which way you're going to go, but the market will react.

[308] Interest rates drive the decision for me as a businessman, not necessarily the tax rate. That's the secondary consideration and I think it would be for my kids.

[309] MR. PORTMAN: Ultimately we get back to fiscal and monetary policy and its interplay with all this.

[310] Thank you all very much.

[311] MR. CRANE [Presiding]: Ms. Johnson?

[312] MS. JOHNSON: Thank you. We do have a vote so I'll keep my question short and maybe one other person can get in.

[313] Ms. Didrickson, nice to have you. I enjoyed visiting with you last weekend and hearing --

[314] MS. DIDRICKSON: Thank you, Congresswoman Johnson, I did to.

[315] MS. JOHNSON: -- a lot about the example that you are setting -- and I know there are other state administrators who are setting this example, too, but certainly you and the treasurer in Connecticut have really taken the lead in really making government more efficient and downsizing its costs and in improving its performance. Really I commend you on your success.

[316] Your testimony interested me in this regard. If we go to a flat tax and we define the minimum taxable level differently --

[317] MS. DIDRICKSON: Right.

[318] MS. JOHNSON: -- than it is currently defined, and we define the base differently than it is currently defined -- excluding a lot of income that is currently taxable -- then the take of any state income tax is going to be diminished.

[319] MS. DIDRICKSON: That's correct.

[320] MS. JOHNSON: And either you will have to tolerate that loss of revenue, or you will have to have your own structure, which means that the whole goal of simplicity will be apparent and not real. That concerns me.

[321] It looks from your testimony and from that of a number of the rest of you that, if we don't do this in harmony with you -- at least now there's a certain harmony. People can figure out what their state taxes are, deduct them. I mean, the two systems have sort of become somewhat integrated and simplified.

[322] But, if we do this certain ways, we could end up forcing both municipalities and states to have their own tax law so they can define a base that will yield in the revenue that they want and a rate -- a level of income eligibility -- that will yield them the base. That really concerns me. I hadn't quite realized the possibility of this really -- enormously difficult complexity that could result from, quote, simplification of the federal.

[323] MS. DIDRICKSON: I don't think that it means, necessarily, that our tax system in the state of Illinois, our flat tax, would become more complicated. But it does mean that we are one -- out of the seven flat tax states -- we are one of the four that uses the AGI, the adjusted gross income. So, we would have to change our baseline to reflect that. That also means we would have to make revisions within our tax code and determine what kind of revenue we would be producing.

[324] Those are decisions we would need to make at the state level, but those are decisions that I believe that we very well could answer and make at the state level. But that gets back to the position that NASACT has requested along with NAST and a number of the others, which is, give us enough time to be able to react to it. It doesn't mean that it's not doable; and I do not believe that it makes it more complicated.

[325] But we do have to make adjustments and one that you've raised there is one that I raised in my testimony with regard to the base line.

[326] You also mentioned the fact that there are a number of states that are looking to become smarter, smaller; and clearly, there probably isn't a constituency for maintaining the IRS and its 100,000 employees and what's a $10 billion annual appropriation.

[327] So, I think that we need -- and I believe that concertedly together the federal government, the state governments really need to be able to look to a system that will provide simplicity, make the taxes flater and make the simpler to conform. I think that's a goal that we at the state are certainly looking to do; and I believe that -- I'm delighted that you at the federal level are doing the same thing.

[328] MS. JOHNSON: Mr. Holden.

[329] MR. HOLDEN: Congresswoman, I believe there's 37 states that are tied directly or in some fashion to the federal tax system. To make a major change, you're going to talk about a lot of states having to come in and address this issue.

[330] What the chairman said a while ago about wanting to work with the states and local communities I really appreciate. Because, we are all in this together. What you do up here is going to have a very dramatic impact on how we address these issues at the state and local level.

[331] As you come forward with your ideas on what you're seriously taking a look at, I would encourage you to touch out and reach all our organizations, give us the specifics that you're wanting, let us go back and talk individually with our states to come forward so that you have the best information possible; and try to come forward with a comprehensive, focused tax reform bill that I think we all really would genuinely like to see happen.

[332] MS. JOHNSON: I guess in closing what I think is very important for you and all your organizations to do is to look at what you think the definition of taxable income ought to be under, say, a flat tax scenario.

[333] Because, if we exclude whole categories of income, that will have a lot of influence on what rates you are obliged to look at. Then I think it's very important that there be some agreement among the states and the federal government as to what's going to be deductible so we don't get into an erratic pattern where deductions vary widely across the states and are very different from the federal pattern.

[334] We need as a society to decide whether charitable deductions are in or out, whether home mortgage deductions are in or out, whether R&D credits are in or out; and health premium taxes and so on.

[335] So, if we should go in the flat tax direction and we don't come to some agreement on the nature -- the definition of the base and the basic deductions, then we have the potential to have a really enormous impact --

[336] CHAIR ARCHER: The lady's time has expired; and our time is about to expire to make this vote.

[337] I want to thank each of you -- in fact, I do thank each of you for coming today. I understand there are no further questions, so, this panel is excused; and after we have voted a couple of times, the committee will come back. In the mean time, we will be in recess and we'll hear our next panel when we do return.

[338] (Break.)

[339] CHAIR ARCHER: The Committee will come to order, and the chair would like for our next panel of Arthur Lynch, Harley Duncan, Dan Bucks, Frank Shafroth, and Deborah Doxtator to take seats at the witness table.

[340] We either need to rearrange some witnesses or we need to rearrange the nameplates in front of the witnesses. We'll get that sorted out before we commence.

[341] Now, my greetings to each of you as witnesses, and thank you for coming to testify before the Ways & Means Committee. As you are recognized, if you will identify yourself for the record before you commence, and then if you would, please try to limit your oral testimony to five minutes or less. Without objection, your entire written statement will be entered into the record.

[342] Mr. Bucks, would you lead off, please.

[343] MR. BUCKS: Thank you, Mr. Chairman, and members of the committee. My name is Dan Bucks and I'm the executive director of the Multistate Tax Commission. This commission is an organization of 40 state governments, an interstate compact agency that works to preserve federalism and ensure fairness in state taxation of interstate commerce.

[344] This committee is to be commended for these hearings on the state and local impacts of federal tax restructuring. While they have gotten little attention to date, these impacts are likely to prove to be one of the two or three most important issues of all in federal tax restructuring.

[345] The stakes are very high. If Congress fails to deal properly with the state and local impacts, Congress could centralize governmental power in Washington on a scale never seen before in our Nation's history. It could do serious damage to state and local governments across the Nation and disrupt even the most basic and elementary public services.

[346] In particular, if federal tax restructuring centralized more power in Washington, it would reverse Congress' recent efforts to transfer responsibilities to state and local governments in its enactment of landmark protections against unfunded mandates. However, federal tax restructuring could be come the mother of all unfunded mandates and could end federalism in this nation, and with it limit the freedoms and flexibility that are nurtured and supported by federalism.

[347] Now, are these consequences, these dire consequences inherent in any major restructuring of federal taxes? No. Certainly not. Are they possible if some of the current proposals are adopted without significant changes that take account of state and local needs? Most certainly yes.

[348] The state and local impacts of each major federal tax proposal vary, and each proposal should be evaluated from the viewpoint of how much choice it leaves the citizens of the states to fashion their own tax policies.

[349] The current system supports a wide range of choice in state and local tax policy, with sales, income and property taxes being mixed in different proportions across the nation. A major goal of federal tax change should be to leave the citizens of the various states with as much freedom of choice in tax policy as possible.

[350] Consider first the proposals for a national sales tax to replace the federal income tax. As proposed today, these plans to repeal the federal income tax effectively repeal state and local income taxes as well because of constitutional, administrative and international treaty problems.

[351] The federal government provides a legal administrative and auditing infrastructure and a set of international tax treaties that is a foundation for state income taxes. It is unclear how states would be able to reconstruct this infrastructure independent of the federal government. And even if they could, there appears to be a constitutional barrier to independent state income taxes because the due process clause likely prohibits states from requiring information reporting from certain out-of-state businesses.

[352] Income taxes raise 25 percent of state general fund revenues; thus, these current proposals for a national sales tax to eliminate the federal income tax and therefore the state income tax, these current proposals would blow a large hole into state budgets and effectively eliminate income taxes as a policy choice at the state and local level.

[353] If states are also mandated to conform their state and local sales tax basis to the basis of the new national sales tax, virtually all power over state tax policy will be transferred from state capitals to Congress, while the budgets of states and some local governments would have been decimated.

[354] Further, the burden of most federal, state and significant local finance would be stacked upon a single base of sales transactions with the combined rates reaching the stratosphere -- as high as 40 percent or more according to some estimates.

[355] Now, take the example of two states, Oregon and Montana. The citizens of those states have gone to the ballot box more than once to choose income taxes instead of the sales tax as their primary state revenue source.

[356] A national sales tax to replace the federal income tax without protecting state income taxes would nullify the votes of the citizens of those states. They would no longer be able to levy state income taxes and their states would be forced by Congressional edict into a system of sales taxation that they have rejected in free and open elections.

[357] Now, there are solutions to these problems. Congress can take action to enable states to continue to levy income taxes, and it could develop a sales tax in full cooperation with the states. However, these solutions require a level of cooperation and a partnership between the states and Congress that is rarely seen.

[358] Let's turn now to the flat tax in the USA plan. Plans of these types contain broad-based general business taxes that, in fact, have already been pioneered by the State of Michigan, and Congress could well learn from this state experience. In many ways, these broad- based business taxes provide states with a broad foundation of choice to fashion their own business tax systems. So there are some major federalism pluses to these plans.

[359] However, there are also some federalism minuses. By repealing the individual taxes on dividends, interest and capital gains, current flat tax plans effectively repeal taxes on the same items for the states. Again, a state fiscal loss would occur and the policy choices available to citizens would be narrowed.

[360] Tennessee, for example, levies an income tax, only an income tax, on investment income only, and the flat tax would foreclose the policy choice that Tennessee has made. Again, there are solutions, but they require a partnership between Congress and the states.

[361] The USA plan would create incentives for persons to convert deferral of state taxes on saved income into a permanent exemption by moving from one state to another. Both fiscal problems and conflicts among the states will result. And again, Congress and the states need to work together to find solutions.

[362] Now, the Multistate Tax Commission joins with the other organizations who've testified here in calling for the creation of a joint Congressional state staff working group to evaluate the federalism impacts of each major proposal for federal tax change.

[363] Now, beyond that modest step, the Commission also raises a bold and revolutionary idea for establishing tax policy in this nation. Because the relationship between federal and state interests are so great, we propose that those features of any new tax system that overlap federal and state interests be enacted by an interstate compact between Congress and cooperating states.

[364] A compact is the one vehicle consistent with federalism to establish a true partnership between Congress and the states, and the mechanism is ideally suited to preserving federalism as the Nation moves to a new tax system because a compact would require a full consideration and reconciliation of federal, state and local interests involved in a major tax change.

[365] A compact between Congress and the states would also promise an economic dividend. If the base and the intergovernmental features of a new tax system were enacted by compact, the tax system would be more stable and potentially less costly for government, business and citizens to administer.

[366] A base established by compact would be less likely to change, so investors could plan and make investments with the security that they would face fewer surprises from either the federal government or the states.

[367] Coordinated administrative mechanisms established by compact could cut costs of compliance and administration for the private and public sectors alike.

[368] If Congress and the states work together in full and complete partnership, they can both preserve federalism and improve economic growth and efficiency. If Congress does not work with the States, however, the result could dramatically reverse the efforts of this Congress to return power from Washington, D.C. to the states and could be extremely disruptive for state and local governments.

[369] Thank you.

[370] CHAIR ARCHER: Thank you, Mr. Bucks.

[371] Mr. Lynch, would you proceed, please.

[372] MR. LYNCH: Thank you, Mr. Chairman. Good afternoon.

[373] My name is Arthur R. Lynch and I'm the president- elect for the Government Finance Officers. I am the director of finance for the City of Glendale, Arizona, Phoenix being one of our larger suburbs. We appreciate the opportunity to speak before you this afternoon.

[374] Today, I want to describe to you how dramatically and prominently the federal tax policies are linked to state and local government finance in the areas of infrastructure and tax exempt financing, public pensions and benefits, and also in state and local taxation.

[375] Tax exempt bonds will lose their unique standing as tax exempt income under several of the reform proposals. The fiscal consequences of this change are an extremely serious matter.

[376] States and localities will not be able to afford important projects, including federally mandated infrastructure facilities, without this proven source of below market, low cost financing.

[377] Municipal bonds are the only debt instrument available to turn people's savings into schools, subways, tunnels, roads, and other infrastructure facilities. Remedy ing the infrastructure deficit should be one of our national priorities because of the fact that productivity improvements and national economic growth are tied to the infrastructure investment.

[378] The infrastructure deficit particularly hurts businesses that rely on those public facilities to move their finished goods, to acquire supplies, to get things to the market, and to make a profit that can be reinvested.

[379] Let me give you an example of some of the direct impacts that our citizens in the City of Glendale experienced. We just completed going to the financial markets with a bond financing. The tax exempt rate on those bonds was a little below 5 percent. The cost to our city and, as a result, to our citizens, was 5 percent plus the direct cost of issuing, the remarketing risk and those other components that are passed on by the underwriting firms.

[380] A taxable issuance of those very same securities would have resulted in an interest rate of approximately 2 percent higher, not only from the standpoint of the market rate, but also to the city, with the additional taxable cost of issuance that are there from having to tell the story about that particular bond.

[381] If those bonds are taken to the market as a special taxable issue, which we have done those types of issues, they are usually at that higher cost, which means our citizens have paid higher fees, and normally that means that there is less opportunity to complete facilities, roads and other infrastructure which is needed.

[382] Let me address the federal tax provisions affecting the bonds. The federal tax provisions that affect the bonds need to be changed to reduce some of the regulatory complexity, to provide more flexibility for public-private partnerships, and to provide for other innovations. Low-cost tax-exempt financing should not be forsaken, especially in light of having Congress having created the new mechanisms such as state revolving funds for financing wastewater and transportation issue.

[383] Tax-exempt bonds are used to leverage the limited federal contributions that go into these funds, and I would also like to use the example of our citizenry in Glendale as we've used that type of financing.

[384] When we borrowed from the revolving fund to do wastewater projects, our interest rate was obviously subsidized or leveraged by the financial contributions. The interest rate was approximately 3.4 percent, whereas in a taxable market it would have been approximately 5.4 percent. On a $40 million deal, we were looking at what would have been an extra $800,000 in costs to our citizens if it was handled as a taxable deal.

[385] The key point here is that the taxable market requires a higher rate of contribution in terms of interest, which requires a higher federal subsidy also on those loan leverage programs.

[386] What that really means, translated to the average citizen that resides in our jurisdiction, is that there's less accomplished for the municipality in terms of the projects, which means less accomplished for them as citizens of both the locality and our Nation.

[387] Tax reform will jeopardize the creditworthiness of state and local governments and could lead to municipal bond defaults if governments no longer have the revenues to pay their bondholders.

[388] Our revenue systems are so entwined with the federal tax code that national reforms will throw many of these systems into chaos, and I've included more detail about those issues in my written testimony.

[389] One in particular is the loss of income in property tax deduction. If it's eliminated, it would increase pressure on the states and localities to lower existing tax rates, and would certainly make it more difficult to increase taxes to provide additional services in the future.

[390] Let me now turn to my concerns about public pensions and benefit programs. State and local governments provide value to the adequate retirement for employees that are in the public sector. Also, they provide stability for adequate retirement income and health care for the employees and they take a very strong interest in the federal tax policies and support these programs which assist employees in having adequate retirement and health care.

[391] Under all of the leading tax reform proposals, employee benefits would receive less preferential treatment than they do under the current law, and basically the major impact is in three areas.

[392] These are: The change in tax treatment of pensions in contributions will decrease the value of pensions to employees; the plan sponsorship could decline since there would be a higher cost and less supportability; and employees will have a stronger preference for wage income rather than the deferred pension income after reform.

[393] As the health care providers of last resort, state and local governments also are concerned that proposals to tax employer paid health care or health insurance and individual health premiums may shift the payment of health care insurance from employers to employees. This could greatly increase the number of uninsured persons and our health care expenses also.

[394] One of the top problems and issues that has already been highlighted somewhat is the state and local governments might be taxed by the federal government.

[395] One proposal is to require governments to pay a federal excise tax based on the value of fringe benefits provided to the government employees. As the federal government is turning more responsibilities over to the state and local governments, it should not tax them. The central issue of tax reform is one of who wins and who loses. Many of the reform changes would impose higher costs on state and local governments without providing resources or new mechanisms for dealing with those additional costs.

[396] While there are some benefits associated with tax reform, we cannot conclude overall that it is a win-win for states and localities, and if it's not a win-win for states and localities, obviously our constituents will also be sharing in the losing proposition.

[397] Mr. Chairman, members of the committee, we welcome this opportunity to share our concerns with you, and we encourage you to call on state and local governments for your assistance as you continue to review the federal tax policy.

[398] CHAIR ARCHER: Thank you, Mr. Lynch.

[399] MR. LYNCH: Thank you, sir.

[400] CHAIR ARCHER: Ms. Doxtator, welcome to the committee. If you'll identify yourself, you may proceed.

[401] MS. DOXTATOR: Good afternoon, Mr. Chairman and members of the committee. My name is Deborah Doxtator and I am the chairwoman of the Oneida Tribe of Indians of Wisconsin.

[402] We are a member of the Nation of the Iroquois Confederacy from which this American government learned the concept of a government of, by and for the people. We are proud that our model of governmental checks and balances, upper and lower houses, and separations of power became the foundation for the America which we now all enjoy.

[403] We are also pleased that you acknowledge that our government and the treaties under which we have forged a relationship continue.

[404] On behalf of our 13,000 Oneida citizen members and our nearly 4,000 employees, I am honored to speak before you today. It pleases me that this committee understands that we are not simply a race of downtrodden, we are not simply an American minority, we are and since the founding of this country have consistently been a federally recognized governmental entity. As such, we come before you today to express our views on the tax proposals currently being considered.

[405] It is important that Congress clearly understand the unique problems of Indian country before restructuring the tax code. Tax reform without this understanding could cause the already horrendous economic conditions in Indian country to become even worse.

[406] Any new tax structure should allow for the favorable treatment of income which is used for health care, education and housing. It is also imperative that Indian tribal governments be given every opportunity to provide for the needs of their membership, just as any state or local government would.

[407] Each bill should recognize the need for tribes to utilize tax- exempt financing methods and their ability to impose taxes of their own.

[408] In brief, in Indian country, the unemployment rate was at 56 percent in 1990, and on some reservations it exceeds 85 percent. Of the two million American Indians and Alaskan natives in the United States, 605,000 live below the poverty level. The median family income of all American Indian families was $21,750, compared to $35,225 for all American families in 1990. The on-reservation per- capita income level was 4,478, compared with 8,328 for all Americans in 1990.

[409] As established under Revenue Ruling 67-284, Indian tribal governments are not subject to federal taxation on their income. Tribal agencies and enterprises depending on how they are organized share the same exemption from federal taxation on their income as the tribe itself. However, Indian individuals who reside and work on the reservation where they are members are subject to federal income taxation unless a federal treaty or statute provides an express exemption.

[410] Unfortunately, several taxes which states are exempt from paying, including unemployment and insurance contribution taxes, were not listed as a part of this act. We strongly believe tribes should be able to enjoy the same immunity from federal taxation that Congress has given to the states, and we hope that Congress would use this opportunity to correct this inequity.

[411] The committee has asked that I focus on how the proposed replacement systems offered by various members of Congress would impact Indian tribal governments. Although it is difficult to address the advantages and disadvantages of each of the proposed bills, I can outline some general themes based upon the ways in which Indian tribal governments currently function, and how these changes might impact individual Indian people.

[412] In regard to the flat tax proposal, the treatment of tribal governments and tribal-owned agencies and enterprises under the tribal flat tax is okay. The Armey flat tax proposal contains a blanket exemption from the business tax for an activity of a governmental entity.

[413] We would propose that this section of the bill be clarified to include an express exemption for Indian tribal governments and their subdivisions.

[414] The Armey flat tax would apply a flat 17 percent rate to wages and pension distributions received by individuals. It is important to note that Indian tribes as employers are currently not eligible to offer salary deferred pension plans to our employees.

[415] We encourage Congress to move on legislation allowing tribes to utilize 403-B and 401-K plans. The family living allowance appears to be within reason when considering the per capita income levels of Indian people overall. Under this plan, a single head of household with three children would be able to earn $29,000 before the tax would begin.

[416] In an effort to encourage non-Indian businesses to locate on reservations, we would suggest that Section 102 of the bill, which imposes a tax on business activities, include a provision to allow taxes imposed by an Indian tribal government to be considered cost of business inputs. This designation has been given to taxes imposed by all other forms of government except tribes.

[417] Regarding the national sales tax, these bills would impose a 15 percent national retail sales tax on the use, consumption or enjoyment of any taxable property or service. State and local governments would not receive an exemption from the sales tax according to the House version of the bill.

[418] Clearly any tax structure which imposes a sales tax on the Indian tribal government would not be supported by tribes. These governments engage in various enterprises in an effort to generate funds to support the needs of their citizen members, and they're often the largest if not only employer on a reservation.

[419] Imposing a tax on Indian tribal governments will decrease available funds for services and programs. Such a tax would create a hardship on a significant percentage of the tribal governments and impair the ability to meet the needs of our communities.

[420] Finally, the House bill would call upon the states to enforce the sales tax. Historically, states have had little jurisdiction over matters occurring on Indian lands, and tribal governments would oppose expanded state jurisdiction within the boundaries of a reservation.

[421] Tribes would prefer to either collect the taxes on sales within the boundaries of a reservation and forward those tax revenues to the federal government or compact with a state or local government for the collection of such taxes within the boundaries of the reservation.

[422] Regarding the consumption based tax, this proposal offered by Senator Domenici provides no exemption for tribal governments or tribal entities from its consumption based business tax.

[423] States and local governments are exempt from taxation on any gross profits derived from the exercise of any central government function. Only mass transit and public utilities services are treated as essential government functions. However, the government of any possession of the United States is exempt from any tax on gross profit earned by that possession.

[424] Section 252 of the bill states that the governmental entities are subject to tax on any business activity of a type frequently provided by business entities. Again, tribes would be severely impacted by such a broad determination. At a minimum, the term "frequently provided" must be defined to consider the unique nature of Indian tribal governments and where they are located. Oftentimes activities are not carried out on reservations unless provided for by the tribal government.

[425] Mr. Chairman, due to the ambiguities of the status of Indian government in these proposals, it is obviously difficult for us to give specific guidance to the committee on which avenue of reform would be most beneficial and appropriate. It must be clear, however, that the unique status of Indian nations under 200 years of federal Indian law and federal policy must be considered as serious reforms are undertaken.

[426] Because the elected leadership of our Nation must also be responsive to the needs of our constituents, the services which we provide when meaningful revenue can be secured closely mirror those of other more familiar levels of government, and because the range of need in most of our communities is so vast, I call upon the good offices of your committee to include favorable language toward these governments and their constituents.

[427] Taken broadly, we would be supportive of provisions that acknowledge Indian governments as governments and not within other categories of tax consideration.

[428] We ask that consideration be given to Indian governments regarding pensions and related benefits, and acknowledgement of the appropriateness of their inclusion in the Section 102 cost of business input opportunity.

[429] Lastly, we would encourage the committee to consider the recommendations offered by Senator McCane in S- 1306. These provisions would help alleviate problems associated with tax exempt bonding.

[430] Mr. Chairman, I thank you very much for this opportunity.

[431] CHAIR ARCHER: Thank you, Ms. Doxtator.

[432] Let me, for the benefit of all who are within earshot make sure that this country knows that the Armey flat tax actually is a 20 percent tax in the first two years, anticipated to go down to 17 percent in the third year provided economic growth is adequate to make additional revenues available. So it is not a 17 percent tax, but rather a 20 percent tax.

[433] And I'm not being critical of you; it's just that's the way it has been presented, and it's not accurate to present it as a 17 percent tax.

[434] Our next witness, Mr. Shafroth.

[435] MR. SHAFROTH: Thank you, Mr. Chairman.

[436] CHAIR ARCHER: If you will identify yourself, you may proceed, and we'll be pleased to receive your testimony.

[437] MR. SHAFROTH: Thank you, Mr. Chairman.

[438] My name is Frank Shafroth and I'm representing the National League of Cities, which is the largest and oldest organization representing the Nation's municipal elected officials. We represent approximately 140,000 municipal elected officials in some 17,000 cities and towns across the country.

[439] We especially appreciate your leadership, Mr. Chairman, in calling for this hearing. We were a concern to be excluded from the Kemp Commission, and so there was no local representation. We think the importance of recognizing the three federal system we have of states, local governments, and the federal government is critical in the nature of tax reform.

[440] Just to give you some idea of the importance of this issue to our membership, our board of directors voted last month to make this one of the five highest legislative priorities for the organization in 1996. That came just three weeks after our Election '96 Task Force met in Wichita, Kansas.

[441] A key member of that commission is Hal Dobb, a former member of your committee, and they made this one of the six critical issues where they will seek to have every member running for Congress, the Senate and the two Presidential candidates address the impacts of tax reform proposals at the local level. What will it mean for the citizen in Houston or Bellevue, Washington, not jus for their federal tax returns, but for their state and local tax returns.

[442] We think federal tax reform could have profound impacts on local governments, local capital budgets, local kinds and levels of taxes, and local cost of borrowing.

[443] Sweeping changes of after federal tax income potentially shifting much greater federal tax liabilities to middle income families and cities, could have local economic and sales tax impacts as these families suddenly find themselves with less disposal after- tax incomes.

[444] Major shifts in how federal revenues are raised could preempt traditional state and local revenue sources or could impose vast shifts in relative liabilities, imposing harsh penalties on many states and cities which are dependent upon sales taxes, for instance, as compared to other cities and states that rely upon other sources of revenue.

[445] Perhaps more importantly, and I think not well understood, cities, by 1992, only received 3.5 percent of their total revenues from the federal government. Of increasing importance are state and local tax revenues as they affect local budgets.

[446] Under the President's budget proposal, which the House Budget Committee could look at as early as tomorrow, the President has proposed reductions in programs affecting public capital investment in the range of 40 percent over the next six years, far increasing the importance of tax exempt municipal bonds as the main source of more than 70 percent of public capital finance in the United States with those implications for the economy.

[447] We share as an organization many of the concerns that some have with regard to tax reforms about the low savings rates of Americans, the dissavings at the federal level, and those provisions of the current Internal Revenue Code that encourage consumption and borrowing over savings and investment.

[448] Finally, we hope that a serious look at federal tax systems will enable your committee to look at the generational consequences of our current system. We note that under either the proposal adopted by Congress and vetoed by the President last December, the President's proposal, the growth and entitlement spending for Americans over the age of 65 would grow at a rate of 16 percent over the next six years, continuing to accelerate the proximity of insolvency for both the Medicare and Social Security trust funds.

[449] With regard to the specific systems, mostly I'd like to focus on -- and Mr. Chairman, I tried to provide a chart to look at the specific advantages and disadvantages of each of the major proposals so you can see it on one sheet. Let me comment just briefly on two of the main alternatives, the flat tax and the national sales or consumption tax.

[450] Looking at the flat tax, we think it has certain potential benefits for cities. Those benefits are that it could enhance state and local tax revenues for those states that are piggybacked on the federal system.

[451] To the extent federal tax expenditures are eliminated, those that piggyback might realize more income at the local level. We think it would discourage some of the efforts at avoidance, both of the legal kind you discussed, Mr. Chairman, and of the other kind.

[452] We think there would be relatively less disruption of the current system in place at the state and local level with some kind of a flat tax system.

[453] We think a flat tax -- our belief is that the Tax Reform Act of 1986, which reduced tax expenditures by $200 billion, created a more simple code, lower rates, easier collection and enforcement, and a national perception of greater fairness to almost all taxpayers.

[454] Those are some of the pluses. There are minuses. One I discussed, and that is the elimination of the preference for tax- exempt bonds. Those would affect not only infrastructure, perhaps increasing the cost of roads, airports, highways, and other capital investment by as much as 30 percent at the state and local level, but also eliminating incentives for leveraging private investment for housing. The last form of low income housing construction we have left is the low income housing tax credit.

[455] Three other concerns in the flat tax area.

[456] For every winner, there is a loser. That is, if one person under a flat tax pays significantly less in federal income tax, then someone else would pay more, generally grouped by economic income.

[457] In the past 30 years, the relative level of per capita income has shifted dramatically between cities and suburbs, so a flat tax could have dramatically different impacts depending upon where an American lives, with net results with total revenues for local governments.

[458] Similarly, at least one major flat tax alternative by taxing wages and benefits and not other forms of income could exacerbate the generational concerns that we all have, because it would mean retired Americans would be exempt from any taxation in the future. The full burden of taxpaying would fall upon citizens that work. Again, that would have both geographical and generational consequences for Americans.

[459] Let me turn briefly to the national sales tax. As with other proposals, we think any proposal that helps to discourage consumption, to discourage borrowing and encourage savings and investment is a net plus for the economy for all three levels of government; however, we think a national sales tax could have a more disruptive impact on cities than any other tax reform alternative.

[460] It would mark a major form of intrusion into a field of taxation heretofore almost entirely reserved to states and local governments.

[461] Perhaps most importantly, it would impose, I think one of my colleagues used the term a mother of all mandates, a significant collection and enforcement cost on state and local governments. No two states have the same form of sales taxes. I think, Mr. Chairman, you'll recollect the years we spent between the committee and the Internal Revenue Service trying to deal with gas tax avoidance by the Mafia, dealing with changes in the Code to requiring dyeing of certain kinds of fuel; enormous difficulty, as we experienced this morning in your mark-up, with determining who ought to be subject to that federal gas tax? Does it apply to schools? To ambulances? To police cars? What kinds of public vehicles ought to be covered? What ought to be exempted?

[462] Perhaps more seriously in the national sales tax area, this is an area of enormous diversity among cities and among states. Under Mr. Schaefer's proposal, one could see citizens in cities in Alabama and Louisiana paying 40 percent on any services or products as compared to citizens in cities in many other states paying only 20 percent. So vast geographic disparities.

[463] Secondly, because of the nature of the application, one could see in, say, the Seattle, Washington, area, heavily dependent upon the export industry and the software industry, significantly lower federal tax rates compared to, say, Detroit that is almost uniquely dependent upon the domestic automobile industry.

[464] So a national sales tax could have huge and disparate impacts on cities depending upon the region of the country they are located, depending upon the relative income of the citizens of those cities.

[465] I think a value added tax is not very different from the perspective of local governments from a national sales tax -- again, that large, disruptive impact of interfering with what has heretofore been a state and local source of revenue that the federal government has respected.

[466] Finally and most briefly, on the USA tax proposed by Senators Nunn and Domenici, this has some similarity to the flat tax in that it preserves some form of an existing base that states and local governments could rely upon. It's clearly focused on savings and capital investment, which we like, and provides a modest incentive for tax- exempt municipal bonds not present in any of the other major alternatives.

[467] It does eliminate a lot of the current benefits in the Code that are critical to real estate, housing, and low income persons in cities, and those raise concerns.

[468] Generally, Mr. Chairman, that covers, I think, some of the key differences.

[469] CHAIR ARCHER: Thank you, Mr. Shafroth.

[470] MR. SHAFROTH: Yes, sir.

[471] CHAIR ARCHER: Unfortunately, we're under a time constraint because of the two lights and the buzzers for votes; and Mr. Duncan, if you can limit your presentation to four or five minutes, then we can complete this panel and excuse this panel when we go to vote.

[472] Mr. Duncan, you may proceed.

[473] MR. DUNCAN: Not a problem, Mr. Chairman.

[474] My name is Harley Duncan. I'm executive director of the Federation of Tax Administrators, the Association of the Principal Tax Administration Authorities in each of the 50 states, New York City, and the District of Columbia.

[475] It's a pleasure to be here and I want to commend you for holding a hearing on this often ignored issue and aspect of federal tax reform.

[476] The Federation does not have a position for or against reform generally or for or against any particular proposal. Instead, my purpose today is to try to highlight for you the interrelationships between state and federal income taxes and from that to demonstrate that the types of federal restructuring proposals being considered by this committee will have profound effect on state tax systems that have not been fully identified and analyzed, but need your serious attention as you evaluate restructuring proposal.

[477] First to the relationships between state and federal income taxes. As you've heard, in the interest of simplicity for taxpayers and compliance at the state level, states currently model their personal and corporate income taxes after the federal income tax. States conform closely to the definitions of income and items of expense. All but five of the states begin their state and personal and corporate income tax with the federal starting point; similar numbers use federal definitions for items of deduction.

[478] In addition, states rely extensively on the Internal Revenue Service and their enforcement and compliance programs. In many cases, this is the only outside review of the report for the taxpayers, and it's really not practical to expect states to step this up considerably given that our income tax rates are about one- fourth the level of the federal level.

[479] Finally, states are reliant on the federal information reporting mechanisms both to receive those reports and really to have the legal authority or to exercise legal authority over payers.

[480] Because of these relationships, it will be difficult if not impossible for states to maintain and administer a personal or corporate income tax of the nature that's now imposed without a counterpart federal tax.

[481] In my estimation, proposals which call for the repeal or fundamental alteration of the federal income tax will effectively repeal state income taxes and require that they be modified in manners which mirror the federal changes.

[482] To attempt to duplicate the federal structure, the infrastructure that's currently there, would be a daunting tax and would increase significantly the resources that the states would have to expend. More importantly, it would increase the burden on taxpayers because of the lack of uniformity that would likely result.

[483] In short, if you repeal the federal income tax, you repeal state income taxes; and if you make fundamental changes, you will also make fundamental changes in state income taxes.

[484] Quickly, to some of the impacts, the first and foremost one is that as in any other restructuring proposals that are now under consideration, the states would have fewer tax policy choices available to them after the reform than they do at the present time.

[485] The national sales tax or a transactional value added tax has the most extreme impact from a tax policy choice perspective because it does effectively repeal the federal income tax.

[486] There are a number of issues regarding possible state administration of a federal national sales tax that I would encourage you to examine as well.

[487] A final issue to consider is that there is a corollary effect of as you make changes that the states must model, you shift the focus of authority over state income taxes and state tax basis to Washington at the same time that you are devolving authority and expenditure responsibility to them.

[488] The central point, Mr. Chairman, is the relationships are so intricate between them that they require very close examination, and we would ask that you work closely with state and local governments as you design your proposals.

[489] CHAIR ARCHER: Thank you, Mr. Duncan, and thank you for giving back a little of your time.

[490] The committee will stand in recess.

[491] [Recess.]

[492] CHAIR ARCHER: The committee will come to order.

[493] Mr. Randall Fields, Dan Wilford, William McLin, the Honorable William Lukhard, would you please take seats at the witness table.

[494] Is Mr. Fields here?

[495] Gentlemen, thank you for coming to give us the benefit of your thinking on this structural tax reform consideration we are building toward. Let me again ask you if you will summarize your oral testimony to within five minutes, we would be greatly appreciative, and your entire written statement will be entered in the record.

[496] So, Mr. Wilford, would you identify yourself and then proceed.

[497] MR. WILFORD: Yes, sir. Thank you, Mr. Chairman, members of the committee. And Chairman Archer, I bring you greetings from your many, many friends in Houston.

[498] CHAIR ARCHER: Thank you.

[499] MR. WILFORD: Thank you for the opportunity to testify today about the impact of tax reform on tax exempt health care organizations.

[500] My name is Dan Wilford. I'm president of Memorial Health Care System in Houston, a private not-for-profit health system with five acute care hospitals, three specialty hospitals, and numerous out- patient facilities, all serving the community of Houston.

[501] I'm here today representing VHA, an alliance of over 1,300 not- for-profit health care organizations. Memorial is a charter member of VHA.

[502] First let me say that VHA supports the efforts to make the code, the tax code fair, simpler and more efficient. The task ahead is daunting, and VHA wants to be involved in the process.

[503] While we support reform, we hope the committee keeps in mind the special role not-for-profit health care organizations play in meeting the needs of individuals and communities where government is either unwilling or unable to respond.

[504] Unlike investor-owned hospitals, which are accountable to stockholders, not-for-profit hospitals are accountable to the communities we serve. Not-for-profit health care organizations continue to play a vital role by not only providing care to the medically indigent, but by working in communities to improve overall health status.

[505] Between private community hospitals and state or local government hospitals, the not-for-profit sector accounts for 86 percent of all community hospitals in this country. VHA is concerned that some of the proposals may jeopardize not-for-profit health care. Our concerns are focused in three areas: Application of new taxes to core activities of not-for-profit providers; elimination or dilution of essential tax incentives such as exclusion for tax exempt bond interest and the deduction for charitable contributions; and possible increases in state and local taxes which could be triggered by a major change in federal tax status of charitable health care organizations.

[506] Now I will briefly comment on the proposals that may affect not- for-profit hospitals.

[507] The flat tax would accommodate an exemption from tax for not- for-profit health care organizations; however, we see two major disadvantages of this proposal.

[508] First, it would effectively eliminate the tax exempt bond market. Hospitals that rely on tax exempt bonds to fund capital improvements would be forced to acquire debt at higher interest rates. This would jeopardize the availability of capital for some not-for-profit hospitals.

[509] The flat tax would also eliminate or restrict the deduction for charitable contributions. Many tax exempt hospitals rely on donations to fund expansions, education, research and charity care. Eliminating the deduction for charitable contributions may affect the ability of not-for- profit hospitals to continue their broader mission of service to the community.

[510] A 15 percent national retail sales tax poses a threat to not- for-profit hospitals. The tax is essentially a sales tax applied to all services provided by not-for- profits that are, quote, commercially available, end of quote.

[511] Although investor-owned hospitals comprise only 14 percent of the in-patient hospital market, they do have a presence in most major markets; therefore, many services provided by the not-for- profit hospital would be commercially available. This would have a more devastating financial impact than the simple loss of tax exemption under the current law.

[512] The value added tax has some of the same disadvantages as retail sales tax, though it would be possible to craft workable exemptions for not-for-profit hospitals.

[513] The USA tax preserves a core exemption of not-for- profit hospitals, the deduction for charitable contributions, and the special treatment for tax exempt bond interest income. However, the taxes imposed on unrelated income -- on unrelated business income could adversely affect hospitals.

[514] Overall, VHA believes that the imposition of new taxes on health care organizations, the elimination of tax exempt bonds, and the denial of charitable deduction could put not-for-profit health care into jeopardy.

[515] We urge the committee to consider the important role of not-for- profit health care and design provisions in any new tax code that will preserve our unique role.

[516] We appreciate this opportunity to present our thoughts to this committee and wish you the best as you pursue your work.

[517] CHAIR ARCHER: Thank you, sir, Mr. Wilford.

[518] Mr. McLin, if you will identify yourself for the record, you may proceed.

[519] MR. McLIN: My name is Bill McLin. I'm speaking on behalf of the Independent Sector.

[520] I'm the president of the National Health Council, an umbrella organization of more than 100 national health related groups. The Council's core membership is composed of America's leading voluntary health agencies, including the American Cancer Society, the Arthritis Foundation and the National Easter Seal Society.

[521] These voluntary health agencies provide unique and indispensable services to individuals and their families, to those who have debilitating and life-threatening illnesses, chronic health conditions, and physical and developmental disabilities. These services are made possible by the generous support of the donating public.

[522] I'm appearing today for the Independent Sector, a national leadership forum working to encourage philanthropy, volunteering not- for-profit initiative, and citizen action.

[523] Let me be clear at the outset that the Independent Sector does not support or oppose tax reform. My testimony is limited to some of the consequences that various tax reform proposals may have on the ability of charitable, educational and religious institutions to continue to provide the services that constitute their reasons for being.

[524] Tax reform poses two direct challenges to the independent sector: first, whether charitable organizations will continue to be exempt from a replacement tax system to the same extent as at present or whether a new system will shift some of the burden of revenue production to non- profits; second, whether a replacement tax system will offer incentives for charitable giving, and whether those incentives will be as broadly based and effective as in times past.

[525] The impact of tax reform on charitable organizations cannot be taken out of context of other developments that affect them. The structural tax reform debate comes at a time when charities are facing great challenges.

[526] As the federal government begins the process of cutting domestic discretionary spending, many are calling on charities to take up the slack, and I say we will do what we can, although it is unlikely that charities can increase private contributions enough to make up for federal tax cuts.

[527] Tax exemption for charitable educational religious institutions is deeply rooted in American history and has been a feature of every federal income tax law enacted since 1863. Charitable tax exemption embodies the American tradition of independence, pluralism, and of pragmatic problem solving, and provides a way of government to support private efforts that improve the collective well-being.

[528] It recognizes the public interest in a system that allows volunteers to create a diversified fluid group of private organizations that can initiate new projects to respond to new leads, offer alternatives to government as the sole provider of service, and act in areas where government is forbidden or it ought not to act.

[529] Finally, tax exemption recognizes that charities build communities by mobilizing private resources for the public good, not private gain.

[530] The second key issue to non-profits is maintaining tax incentives for charitable giving. In 1992, approximately 32 million taxpayers who itemized deductions on their personal income tax returns reported about 63 billion in charitable contributions. Quoting from the accounting firm of Price Waterhouse, this amount would have been $20 billion lower if contributions had not been deductible.

[531] Deductibility of contributions recognizes a general principle that income and assets that are given away to charity are not used for personal benefits. Deductibility is an important aspect of pluralism.

[532] The charitable deduction has endured through five years -- five wars, a depression, innumerable recessions, budget surpluses and deficits, and top marginal rates ranging from 15 to 90 percent. It is economically important to charities, but it is also highly symbolic of the importance of the unique role charities play in American society.

[533] People contribute to charitable causes because they are motivated to help others, not to gain a tax deduction; however, deductibility does influence how much they give. People who itemize deductions make larger gifts than people who do not itemize -- a fact that holds true across all income levels.

[534] In 1980, when the top marginal rate was 70 percent, and in 1993, when it fell to 39 percent, there were substantial drops in the average amount given by all income groups of $100,000 or more.

[535] Sales tax, value added taxes, pose two problems for charities. Neither is conducive to maintaining tax incentives for charitable giving and both are likely to result in direct taxation of exempt organizations.

[536] The key exemption issue for charities and either a national sales tax or a value added tax is whether they would be compelled to pay tax on the goods and services they buy, collect tax from the goods and services they provide, or be exempt on both counts.

[537] Lack of full exemption will transfer some portion of the Nation's tax burdens to charities. National sales or value added taxes also lack an incentive for charitable giving. People who receive additional income because of the abolition of the income tax have no tax incentive to give that money to charity. Since no tax is due until consumption occurs, they can simply keep and invest the extra income.

[538] We hope that many of these people will be motivated to give a portion of their additional income to charity, but it is unlikely that additional contributions will make up for losses caused by the loss of the charitable deduction.

[539] In closing, Brian O'Connell, past president and founder of the Independent Sector, told the Senate Finance Committee in 1982, and I quote, "A flat tax or a value added tax or any other kind of tax will not destroy the willingness of Americans to give of themselves for the larger good, but any tax restructuring that eliminates the charitable deduction will suddenly remove one of the ways this country has found to enhance giving. The resulting decrease in giving will move us away from the very kind of society we've determined that we want."

[540] These words are as true today as they were 14 years ago.

[541] Thank you, Mr. Chairman.

[542] CHAIR ARCHER: Thank you, Mr. McLin.

[543] Is Lukhard correct or --

[544] MR. LUKHARD: Yes, sir.

[545] CHAIR ARCHER: Is that how you pronounce your name?

[546] MR. LUKHARD: You pronounced it right. That's right.

[547] CHAIR ARCHER: Mr. Lukhard, if you will identify yourself, you may proceed.

[548] MR. LUKHARD: Thank you, Mr. Chairman. I'm William Lukhard. I'm chair of the Government Relations Committee of the United Way of Virginia.

[549] I'm here today on behalf of the United Way of America, its 1,400 state and local United Ways across the country, some 44,000 affiliated agencies providing a variety of human services, and particularly the millions of people they serve. And I thank you for the opportunity to provide the committee with our perspective on structural tax reform.

[550] We recognize the complexity of our current tax structure and support efforts to induce fairness, simplicity and equity into the tax system; and as of this time, United Way has not embraced any one tax package or set of reforms over another. However, we strongly believe that the charitable deduction is a significant contribution to philanthropic behavior.

[551] As an example, in 1985, non-itemizing taxpayers were permitted to deduct 50 percent of their charitable contributions. The results was $9.5 billion. In 1986, they could deduct a full 100 percent, and according to the Internal Revenue Service, they gave $13.4 billion, an increase of 40 percent.

[552] The Tax Reform Act of 1986 flattened individual tax rates, attempted to close loopholes, and removed the charitable deduction for non-itemizers. The Act also reduced the value of charitable deduction by imposing a 3 percent floor on those deductions for high income taxpayers.

[553] Again according to IRS information, among the taxpayers with incomes let's say of over $1 million or more, the average charitable deduction per tax return dropped from slightly over $207,000 to slightly under $109,000 from the years 1980 through 1993.

[554] Where some data show that, as the previous gentleman said, that Americans give to charity for reasons not solely related to contributions being deductible, we believe the charitable deduction is an influencing fact on the amount and timing of the particular gift.

[555] We have reservations about the proposed national sales tax and are examining the potential consequences that tax would have for non- profits. We are concerned about the potential regressive nature of the tax and the potential costs that would be borne by charities, not only in the sense of the direct taxes that might be paid by the non- profits for the goods and services they purchase or that they may have to charge for the services they deliver, but also the regressive tax nature on the lower income individuals.

[556] Hypothetically, for example, someone earning between, say, $10,000 to $15,000 a year, with a 15 percent sales tax, would be paying $1,500 to $2,250 taxes. That's in the pure form. Obviously they're not paying that type of tax now in terms of income tax. They will likely be saving very little, if any; and, therefore, their needs on these service agencies will become greater.

[557] In the aggregate, then there will be more demand on these agencies. If we do away with the contribution deduction, then there will be less resources for the agencies to serve these particular individuals.

[558] With regard to the flat tax system, we're again concerned about its potential regressive nature. There are proponents of the flat tax who suggest that individual giving will increase as disposable income increases. While it is possible that if we increase our efforts, giving could increase, we're concerned that the decline in individual giving will not be reversed by a flat tax.

[559] The tax proposal of Senators Nunn and Domenici merits attention because it might not reduce incentives to give as much as the flat tax would.

[560] More study is needed on each of these plans to determine what impact tax reform will have on charities. But regardless of what proposals are advanced now or in the future, we would encourage you to look carefully at all the available studies and data relating to the matter.

[561] With a continuing decrease in federal and state funding, we have been hearing that charities will be expected to do more. If this be true, changes in the Tax Code should provide greater incentives, not disincentives, to charitable giving.

[562] We urge you to review the matter carefully, and particularly to assess whatever behavioral consequences there may be for individual taxpayers.

[563] United Way supports high quality services for millions of Americans, from child care, to emergency services, to services for the elderly. United Ways and their affiliated agencies work to enhance our communities and the lives of our neighbors.

[564] We believe that any effort to reform the tax system should continue to encourage charitable giving and be supportive of the valuable activities of our charitable community.

[565] I thank you again for the opportunity to testify.

[566] CHAIR ARCHER: Thank you, Mr. Lukhard.

[567] Mr. Fields, welcome to the committee, and I would like to repeat what I said a little earlier generally, that we would appreciate it if you would keep your oral testimony to within five minutes. Your entire written statement will be submitted and printed in the record. If you'll identify yourself for the record, you may proceed.

[568] MR. FIELDS: Thank you, Chairman Archer, and I apologize for being late. We thought that you had a few more votes maybe to take care of. But I apologize for that.

[569] CHAIR ARCHER: You're just in time. No problem.

[570] MR. FIELDS: Thank you very much, sir.

[571] My name is Randall Fields. I'm an attorney in private practice in San Antonio, Texas, and I manage the Business and Health Law Section of Johnson, Curney & Fields in San Antonio.

[572] In addition to my profession, though, I'm also very active on a voluntary basis in a number of religious, educational and charitable organizations. I currently serve as the chairman of the Board of Regents of the Baylor University System. Baylor is the Nation's largest Baptist university; we have a 12,000 student campus in Waco, Texas. We also oversee the Baylor Medical Center in Dallas, Texas. I'm also the founding president of a foundation to support our public school district in San Antonio, the North Side Independent School District, which serves about 60,000 students.

[573] In addition to that, I'm a past chairman of the Beacon Council of Trinity Baptist Church in San Antonio, which is a 10,000 member downtown church in San Antonio that has extensive community service programs.

[574] But I'm here today as a member of these other groups, but representing the Baptist Joint Committee. The Baptist Joint Committee represents over a dozen Baptist groups and denominations throughout the country relating to religious liberty and separation of church and state.

[575] I would like to make the first point that we feel that any effort to limit or eliminate the tax exempt status of churches and religious organizations would raise serious religious liberty concerns.

[576] So I come to the committee with a perspective that may be a little unique from the other panel members' standpoint in that all of my services that I've mentioned above are purely voluntary. I don't get paid a dime to do any of those, but I do it because I want to to help our community out, and I think that there are many thousands and millions of people like me across the country that proposed legislation would impact.

[577] Now, as a businessman, I can tell you that any segment of our government that has a negative impact on the productivity of the private sector from an economic standpoint should be examined thoroughly and, where possible and of benefit to all the citizens, should be changed.

[578] From that standpoint, we certainly applaud the efforts of Congress and especially a number of the members of this committee for undertaking an examination of the federal tax system. We think it's high time that that be done and, again, as a private businessman, I'm glad that we're doing that.

[579] Our plea today, though, is that in making this examination and any possible adjustment, that we make an effort to maintain and enhance the charitable giving sector from a voluntary standpoint, both in the intermediate term and the long term.

[580] As has been said a number of times before today in previous hearings, any replacement tax system would have ripples throughout the economy regardless of how extensive it was. Our big concern is that in adopting a replacement tax system, that smaller charities especially not be swept under by the tidal wave that is likely to result from that.

[581] I think that you can divide charitable giving into two broad categories. One is what I would label the large capital gifts, and then other gifts that are smaller gifts. And taking the second category first, my feeling is that the smaller gifts have three driving forces behind them.

[582] One is the general state of the economy. Another is the esteem with which the individual charitable institution is held by the publics that serve them. Then the third, to some degree, is the incentive of deductibility. The large capital gifts, on the other hand, have the same three driving forces, but to a much, much greater extent the deductibility that is built into the present tax structure.

[583] Basically what we would ask the committee to recognize, and I know that you do, is that cash flow is so important to all charities that a disruption or a dislocation in the giving of especially large capital gifts over more than a one- or two-year period could have a devastating effect on the charitable sector as far as the smaller charities go. Here, I'm including not only hospitals, educational institutions, but even churches which depend on large capital gifts to maintain their building programs and their efforts to provide community services.

[584] In conclusion, I would just say that any change in the basic tax structure should have built into it a transition period. Chairman Archer has already spoken to that earlier today, and I know that will be on the committee's mind. But the transition period should provide support at least for the large capital gifts that sustain many, many charities.

[585] Without these safeguards, we feel that a number of the smaller charities would cease to exist and, at the very least, go into their endowment. We think that by doing that, that will throw services back on the governmental sector, and that's what we're concerned about.

[586] We appreciate your time and thank you for addressing this important matter.

[587] CHAIR ARCHER: Thank you, Mr. Fields.

[588] Over the years, those of you who have followed my record on this committee will know that there has been no greater champion for private philanthropy and adequate incentives to see that the private sector does more and that the federal government does less. I continue to view that and am very sensitive to that.

[589] But I must also say that in a total perspective, rather than just some isolated limited viewpoint, if we want to give the greatest incentive for charitable contributions using something similar to the current tax code, we would raise the top marginal tax rate back up to 91 percent so that the federal government was in effect paying 91 cents out of every dollar that was contributed and the individual only 9. If our only goal in life is to increase the incentives for private philanthropy, that clearly would be a justifiable way of doing that.

[590] I heard complaints from friends of mine who were in philanthropic or religious institutions complain when we reduced the rate from 70 to 50 because they said that that really was going to be a discouragement to the giving to their organizations.

[591] But clearly, there's got to be a balance in there, and we -- I think you mentioned, at least one of you mentioned that the overall state of the economy has a lot to do with giving, too, and high marginal tax rates, even if you continue with the deduction for charitable contributions, are a big deterrent to an active and vibrant economy and moving the real take-home pay of people forward. So it does get to be a balance.

[592] I also would say that in the perspective of history, I was born in 1928, and I just looked at what the income tax was in 1928. I'm sure you couldn't guess, because I couldn't have guessed had I not just looked it up. The income tax was 1 percent up to $4,000, and $4,000 in 1928 was a massive amount of money. And the maximum rate was 25 percent, and that was over $100,000, which was virtually unthinkable as the earnings of anybody in 1928.

[593] By 1931, the rate had gone down to 3/8ths of 1 percent for the overwhelming majority of all Americans, because once again, that was the rate up to $4,000, and the maximum rate had been reduced 1 percent to 24 percent for over $100,000.

[594] Now, the reason I mention that is that in those days, a charitable contribution had very little incentive under the Tax Code, and I don't propose to tell you that I remember what was happening the day I was born, I'm really not that advanced in my capabilities, but I do remember very well in the middle '30s when I was growing up, and I remember going to church, and I remember the priest saying it was our responsibility to give to others who were less fortunate. We weren't that fortunate ourselves, but we were still given the obligation to give to others who were less fortunate.

[595] The attraction for giving then, as I recall, was that people gave an awful lot. There was no federal program for welfare, there was no social security program, there was no safety net coming from the federal government, and there was no big incentive for charitable contributions in the Tax Code, but the giving was fantastic, people helping other people in the spirit that I think really made this country great.

[596] So I really believe that we can go to that again. I think that heart is still in every American. But I must say to you that I think part of the problem today is that when you go to an American who is paying the kind of taxes that they're paying to government and government has provided all of these safety net programs and all of these problem-solving spending programs, that the human nature in an American is to say, I already gave at the office, don't ask me to give at home. I gave when the IRS came in and told me I had to give.

[597] It always troubles me that people say this is a voluntary tax system. Just try not to be voluntary and end up in prison. I don't call that voluntary. This is a mandatory tax system where the IRS takes from every earner that it can find and locate and mandates that that money come up here, and then it is turned into other spending programs to solve people's problems.

[598] It's very difficult to motivate people that have given massive amounts in all of their taxes to say, yes, I still want to come forward, and I want to help because my heart is there to help other people who are less fortunate with some sort of a program, whether it be health or whether it be religion or whether it be poverty or whatever it might be.

[599] So I would only say that I appreciate your testimony and I understand where you're coming from. And we've had this system for so long that it's hard to perceive how we might survive without it. But we will definitely, in whatever we do, as far as I'm concerned, attend to being sure that there will be adequate opportunity for people to give, to help other people in a philanthropic way. And that's what all of you are about and I applaud all of you for it. I think it is one of the great strengths of this country.

[600] So I'm very glad to get your testimony and I just want you to know that whatever we do, I'm going to be very sensitive to the kind of work that you're out there doing.

[601] Any other member wish to inquire?

[602] Thank you very, very much. I appreciate your coming and giving us your testimony.

[603] Our next panel is Mr. Charles Clotfelter, Sherry Hayes, Eugene Tempel, Peter Swords, and Larry Rosen. If you would come and take seats at the witness table.

[604] There's a little light in the center there that will be green, yellow and red. The green means go, go for it, and the yellow means you've got one minute left, and the red means your five minutes has expired. I'm not going to shut you off at the end of five minutes, but without objection, your entire printed statement will be entered in the record, and if you would summarize and try to stay within that five-minute light for your oral testimony, we would be greatly appreciative.

[605] Mr. Clotfelter, if you would start off, we would be glad to hear from you. And if you will identify yourself for the record, you may proceed.

[606] MR. CLOTFELTER: Thank you.

[607] I'm Charles Clotfelter. I'm a professor public policy studies and economics at Duke University. Even though Duke University is a non-profit organization, I don't represent any organization today. Like most professors, I am a loose canon.

[608] What I would like to do is just highlight some research that I've done with Professor Richard Schmallbeck at the law school on the effects of tax reform on the non- profit sector and charitable giving.

[609] The United States is distinctive among developed countries in the reliance that we put on the non-profit sector and the advantages that we give to the non-profit sector in our tax law, and I don't think that is just a coincidence.

[610] To understand how tax reform plans might affect the non- profit sector and charitable giving, it is useful to focus on two aspects of the current federal tax treatment; that is, exemption and the deductibility of charitable contributions.

[611] How do these affect charitable giving and non- profit sectors? The exemption, of course, relieves non- profit organizations of the responsibility of paying income tax, but more important, it relieves them of the responsibility of having to do a lot of accounting procedures because in effect the income is not going to be there anyway.

[612] The more important aspect is the deductibility of contributions, and that's what we put most of our attention on in our study.

[613] Let me just say a word about how taxes affect charitable giving. There have been numerous economic and econometric studies of the effect of taxes on charitable giving, and I've been involved in some of those. Even though there continues to be disagreement as to the precise effects of taxes, three conclusions seem to be widely accepted.

[614] One, taxes are rarely the dominant motivation for people to make charitable contributions. People give for a wide variety of reasons, and tax benefit is only one effect and is rarely the motivating effect. However, tax policy can effect the amount that people give.

[615] Second, taxes influence giving by determining how much money people have left over after taxes. That is the income effect.

[616] The third thing is that the charitable deduction itself has an impact on the net of tax costs or tax price of giving away a dollar. For example, a taxpayer facing a marginal tax rate of 30 percent gives away dollars to charity that really only reduce his or her consumption by 70 cents.

[617] Tax plans that would either change tax rates or affect deductibility would affect this net cost. Empirically, this tax effect makes a difference and is a central feature in calculations such as ours on the potential effect of tax reform.

[618] Some have questioned whether this tax price effect is really that important, owing to the fact that during the 1980s, even though marginal tax rates were cut twice, charitable contributions continued to keep growing.

[619] In fact, what happened during the 1980s is that the burden of charitable giving really was subtly shifted from upper income classes to the middle income classes, and second, non-profit organizations exerted mightily to continue to get contributions by stepping up their fundraising activities.

[620] To get an idea of how these tax reform proposals might affect charitable giving by individuals, we did some simulations, and what they showed was that the Armey and Shelby and the Gephardt plans would reduce contributions on the order of 10 to 22 percent from current levels; that the USA tax, which keeps the deduction in place, would have increases on the order of 11 to 31 percent.

[621] So in conclusion, even though taxes are not the reason why people give, they do have an impact, and tax reform proposals such as these would also have an impact.

[622] MR. McCRERY [presiding]: Thank you.

[623] Ms. Hayes.

[624] MS. HAYES: Thank you, Mr. Chairman, and members of the committee and staff, for the opportunity to testify today.

[625] My name is Sherry Hayes. I'm vice president of an organization called InterHealth. We are an interfaith inter-industry organization that includes non-profit hospitals, health care systems, social service providers, medical groups, a foundation in New Orleans as a matter of fact, and strategic business partners.

[626] Our values are rooted in the Judeo-Christian tradition of healing as a mission. We view ourselves as partners to both government and for-profit sector, working toward the common goal of a more civil society.

[627] It is with this orientation that we applaud the efforts of the committee and we embrace the discussion of a replacement tax system as a challenge in our mind to better respond to the needs of individuals as well as the needs of those communities.

[628] It is an opportunity as well to revisit some of the underlying principles of tax exemption, something we have not done, frankly, for a very long time around here, to strengthen the federal commitment to and hopefully partnership with the voluntary sector through the removal of current barriers.

[629] Though we do not oppose any approach to tax restructuring, we do have several concerns with the proposals that are being considered.

[630] First, we object to the application of a consumption based tax to health care services that are rendered on a non-profit basis. We strongly recommend that the committee eliminate commercial availability, the standard that currently exists in H.R. 3039, and hopefully work with you to recognize that not all health care is the same, as mediating institutions, particularly faith-based providers, deliver a safety net of services that are either not provided for by government or are not unilaterally profitable in the private commercial market.

[631] In that regard, we sort of see ourselves as buffering some of the rougher edges of capitalism and, in today's vernacular, sort of government bureaucracy.

[632] Beyond the provision of charity care, religiously affiliated hospitals have as a part of their mission the provision of spiritual care. We treat the body, we treat the mind, and we treat the spirit.

[633] These institutions are inextricably linked to their communities, to their families and churches, and they provide preventive as well as healing services regardless of one's ability to pay. It is a mission for us.

[634] To the extent that there are services that are profitable, those margins remain in the communities and within the delivery system as opposed to those being diverted away from the community and the delivery system in a proprietary system by investor-owned entities, things like local stewardship, pastoral care, parish nursing programs, the ministries.

[635] In addition to that, I think the moral institutional culture of some of these systems all contribute not to a commercially available product per se, but to the healing of human beings and the community as a whole. It's unique and it's critical and we would hope that it would be strengthened during consideration of tax reform.

[636] Secondly, whatever approach the committee chooses to take on tax reform, the availability of taxes and financing must be preserved and expanded. Research shows that 95 percent of the interest savings on tax-exempt bonds is returned to the community in the form of charity care.

[637] The current restructuring and consolidation underway in the health care sector is bringing better care and it is bringing more efficiency back to our communities. The current $150 million bond cap for non-hospital debt is a serious impediment to those consolidations, serving as a barrier to the non-profit sector's ability to develop integrated systems of care across communities.

[638] A third point is ancillary, others have made it, but we feel it's significant. That is, InterHealth is concerned that a major change in federal tax status of charitable health care organizations will trigger increases in state and local tax burdens.

[639] Our fourth concern is that current tax barriers to non- profit provision of care be eliminated. We support both the AHA and CHA proposals to enact specific tax exemption for integrated delivery systems and to establish in the Code comparable to the hospital exemption a specific exemption for clinically and financially integrated health delivery networks, imposing appropriate requirements to ensure that they are assessing and addressing the needs of community beyond the enrolled populations.

[640] We believe that coordinated care through non- profit mission- driven delivery systems is a critical component to a civil society. The community focus and accountability, the availability of charity care, and emphasis on whole prevention and healing is, frankly, not a commodity; it is available commercially.

[641] We welcome the opportunity to assist the committee and its staff in thoughtfully addressing these concerns. With such changes, we believe strongly that it would be possible to maintain appropriate support for the mission of religiously affiliated organizations under any of the tax alternatives pending before the committee.

[642] Thank you very much for your time.

[643] MR. McCRERY: Thank you, Ms. Hayes.

[644] Mr. Tempel.

[645] MR. TEMPEL: Good afternoon, Mr. Chairman, members of the Ways and Means Committee. My name is Gene Tempel and I'm vice chancellor of Indiana University-Purdue University at Indianapolis, but I'm testifying today as vice chair of the board of directors of the National Society of Fundraising Executives, NSFRE.

[646] NSFRE is a professional association with 16,000 members, all who generate philanthropic support for a wide variety of not-for- profit charitable organizations. It was founded in 1960. It's a 501(c)(6) organization headquartered in Alexandria, Virginia.

[647] We appreciate the opportunity to discuss the effect of tax reform on tax exempt non-profit organizations. A number of economic studies have been conducted on whether such reform will be helpful or harmful to the charitable sector. My colleagues today have covered this topic and I refer to some of these studies in my own written testimony. But what I want to talk about today is choices.

[648] It seems to me, the choice for nonprofits boils down to this: Should the government encourage or discourage charitable giving? In other words, should the govern encourage those who choose private support of health, welfare, education and other services; or should contributing to the public good be a simple consumer choice at the same level as taking a vacation, buying a new suit or going out to eat dinner?

[649] Americans do have a strong streak of independence and self- reliance. We know that. We also have a strong tradition of philanthrophy -- voluntary action for the public good.

[650] Since colonial days, Americans have helped one another by donating their money to literally thousands of causes from aiding the indigent to creating hospitals and libraries, supporting civil rights, health research and care for children and the elderly.

[651] In essence, Mr. Chairman, the choice we are making is about who we are as a people, and what ideas and values we hold most dear. I believe the government sends strong signals to the public when it makes choices about what it funds, what deductions it keeps or creates.

[652] When Congress created the charitable deduction in 1917, it was expressing the belief that philanthrophy was an important value, that nonprofit organizations were a partner with the government in meeting public needs, and that individuals should not be taxed fully on income which is donated to charity, because that money was used for the public good, not for private or personal advantage.

[653] Although the focus of this hearing is on the elimination of the tax system, the point remains that deduction encourages people to help others and not themselves. It sends the signal to the American people that philanthrophy is an important tradition which should be encouraged and preserved, it helps strengthen American society.

[654] As a professional fundraiser, let me assure you that the American people respond to these signals. Certainly one of the reasons they choose to give is that they believe in the cause -- believe it's the right thing to do -- but almost every contributor I talk to tells me that the tax structure and its deductions play a huge role in giving, particularly as the amount increases.

[655] Just last week, I brought together a group of executives to discuss philanthrophy in rural America. Included in the group was an insurance executive, who recently placed an appreciated parcel of land he owns in a charitable remainder trust. He told me flat out that the charitable deduction to his current income made the gift possible.

[656] While the government may have lost something in taxes, the entire asset is now in the public trust and will be used for needs in rural, southern Indiana. Without the deduction, the property likely would have been sold, some taxes paid; but most of the money passed on to children for private use.

[657] But I want to stress, we're not just talking about the very wealthy. This was a person of moderate income and moderate means just like many contributors. I've also been privileged to work on behalf of the Indiana University Center on philanthrophy and several other countries interested in building a stronger philanthropic base as a means of meeting public needs.

[658] In Mexico and Thailand, for example, we're working with local leaders who advocate for a more generous charitable deduction. It would be ironic for these governmetns to adopt the current US policy on charitable deductions, which they view as a model, while we abandon our own.

[659] I do not believe this is the choice the American people want. The average citizen has said time and time again that there's a unique place for charities. A recent pole by the American Institute of Certified Public Accountants indicates that Americans favor keeping a good charitable deduction by a three-to-one margin.

[660] In fact, this Congress recently asserted the unique position of charities when it unanimously passed the charitable gift annuity legislation. Every member of this committee voted in favor of separating charitable annuities from other annuities because yhou recognize that charitable annuities are not for personal gain, but for public use.

[661] Mr. Chairman, just a few moments ago you referred to the state of philanthropic support in yhour community with a small tax incentive. That was a time of close community involvement and great religous participation. I grew up in such a small community in southern Indiana in the '50s like that myself. But today, we have a loss of community, we have a breakdown in civil society and less participation in religion; so, we believe we need all the tools at our disposal to help encourage local participation and philanthrophy.

[662] In conclusion, I'd like to say that you made it clear that you'd like to tear the income tax system out by its roots and throw it aside. If you can create a system that is simple, equitable and more importantly fair, we will applaud you. Our members at NSFRE are willing to work with you and your committee staff to achieve that goal.

[663] To be fair, however, the new system should recognize that those who make charitable contributions provide for the public good and deserve parity with those who do not by providing the charitable deduction. We have no interest in defending the status quo if reforms are necessary, but when we talk about tax reform and tax policy, we are talking about important choices; choices which will have ramifications for every person in America.

[664] Americans have chosen to make philanthrophy part of their every day lives, partly due to the encouragement received from the government. We simply ask that as the Congress shifts programs from the government to not-for-profits it provide the encouragement for citizens to support those needs at the local level through the strongest signal possible.

[665] Research shows that tax incentives heavily impact the size of charitable gifts. Donors tell us repeatedly that the national importance placed on philanthropy by the charitable deduction sends a strong signal to them when they choose to give. It is our responsibility and the responsibility of Congress to respond to those choices and ensure that the government continues to encourage giving.

[666] Our society, our values, our national character and our individual moral obligations demand no less.

[667] Thank you, Mr. Chairman, for the opportunity to testify and I'll be glad to answer any questions you might have.

[668] CHAIR ARCHER: Thank you, Mr. Tempel.

[669] Mr. Swords, if you'll identify yourself, you may proceed.

[670] MR. SWORDS: My name is Peter Swords and I am the executive director of the nonprofit coordinating committee of New York city, which an umbrella group of some 700 nonprofits of small, various types. I'm also a constituent of Representative Rangel and I want him to be assured that his absence will not affect my vote.

[671] I'm not here to talk about tax reform. I'm here to preach about the importance of the charitable exemption. I want to do that by focusing on the flat tax to make my point.

[672] If you have a flat tax, all deductions will not be eliminated. There will, for example, have to be deductions in order to get from gross to net income. Business expenses are not in the tax base to begin with. Business expense deductions will be necessary to find the tax base of any flat tax.

[673] So, likewise, we believe that money and wealth -- given over forever -- for the good of the whole community, dollars that will not be used for any individual benefit should also not be in the tax base to begin with. We tax dollars and wealth that we would otherwise use for ourselves; and not dollars which will help others.

[674] Thomas Hobbs, a long time ago, said we tax only what we take out of the pot, not what we put into the pot. If you have a flat tax, you will need a exemption for charitable dollars, so you will only tax what we take out of the pot; and we will not penalize the kind of generosity you were talking about earlier, which is what in effect eliminating the charitable deduction would do.

[675] It should be noted that the approach I have been arguing for powerfully confirms one of the principal glories of America's nonprofit sector, mainly its pluralism. Our view of what qualifies for charitable exemption places more emphases on the fact that no one is personally benefitting from these charitable nonprofits than on an evaluation of the nature of the goods they are providing.

[676] Thus, it is up to the founders of nonprofit organizations to decide what is in the public interest rather than leaving the decision to government. Letting the government decide what is in the public interest would be appropriate if the exemption is seen as a way of encouraging efforts the government approves of.

[677] The trouble with this line of view is that the government may change its mind. Today it favors right to bear arms, tomorrow it doesn't. Today it favors affirmative action and encouragement of the arts, tomorrow it doesn't. On the other hand, if the exemption is seen as a tax base provision, as just mentioned, it is up to the initiators and supporters of the individual nonprofits to decide what is in the public's interest.

[678] American history has shown time and time again that nonprofits have identified emerging social problems long before government or political parties have. Furthermore, it is commonplace wisdom that nonprofits are able to respond to problems with more flexibility and creativity than the government can.

[679] Finally, and related to the pluralism point, it is likely that many more Americans now volunteer to work for nonprofits than would be the case if the sector were defined solely by government policy and party politics.

[680] One can believe in the worth of government while simultaneously seeing the great value to our polity of having a nonprofit sector operating independently and parallel to the government in identifying and providing public goods and services.

[681] Who can doubt that such a system offers us a wider range of public benefits, a richer palette of public goods than would be the case if defining the public good was left exclusively to the government? But note, we do away with the charitable tax exemption and tax nonprofits, logic inevitably dictates that the nonprofit sector will wither and the provision of public goods will more and more be left exclusively in the hands of the government.

[682] America will then have given up one of its most significant contributions to civilization. Thank you.

[683] CHAIR ARCHER: Thank you, Mr. Swords.

[684] Mr. Rosen, if you'll identify yourself for the record, you may proceed.

[685] MR. ROSEN: Mr. Chairman, members of the committee, my name is Larry Rosen. I have the honor of being the caboose in these hearings. Thank you for welcoming the opinion --

[686] CHAIR ARCHER: Only for today, Mr. Rosen.

[687] MR. ROSEN: Thank you.

[688] I am the president of the YMCA of metropolitan Los Angeles, which is a community-based, nonprofit, charitable organization of 250,000, 25,000 volunteers in the greater Los Angeles area. About 130,000 of those members are children.

[689] The Los Angeles YMCA operates 24 major full facilities, plus 140 program centers throughout the LA area. Eight of these full facilities and 42 of these program centers are in the innercity of Los Angeles, involving more than 84,000 residents of those areas. They're the only facilities that went completely untouched during the civil disturbance in Los Angeles in 1992, because they are owned by the members of that community. All of these were built and supported by charitable contributions.

[690] I'm testifying today on behalf of the YMCA of the USA and the more than 2,000 local YMCAs nationwide, all of which could tell similar stories. As the committee considers the possibility of structural alternatives to the existing federal income tax, I commend you for taking this opportunity to focus on the implications of tax restructuring for America's charities, these implications are profound and merit careful consideration.

[691] In considering the impact of federal tax policy on America's charities, it is important first of all to consider the importance of charities for America. America is blessed with a charitable sector of incomparable breadth, strength and diversity. Virtually all of us can think of charitable organizations that have profoundly touched our lives.

[692] It is not by accident that the nation which has done the most through its tax laws to support the generous impulses of its citizens, also enjoys such a large, vibrant and effective nonprofit sector.

[693] For millions of Americans, one of those organizations has been the YMCA. Our mission at the YMCA can be sumed up in just eight words: We build strong kids, strong families and strong communities. We accomplish that mission through a far broader range of programs than most people realize, child care, health and fitness, youth sports, camping, team programs and many more. Last year, YMCAs in this nation served over 14 million Americans.

[694] The YMCAs mission has never been more important and the same can be said for America's charities as a whole. America's rich web of nonprofit charities are an invaluable national resource that helps shape our character and lighten our minds, mend together our communities and sustain our democratic process.

[695] In fact, at a time when government is being challenged in many ways to do less or is unable to do more, the nonprofit sector is being asked to do more about pressing social, educational and cultural concerns.

[696] At this time the most appropriate reform of our tax codes might be to seek ways to increase citizen participation in charitable concerns. The status quo will not be good enough as government continues to step back. In the past 15 years, my experience has been that the YMCA has been invited with increasing frequency to come to the table as a partner with school districts, municipalities, county agencies, all seeking to serve with diminishing resources and to invite the nonprofit sector in partnership, an unpaid partner.

[697] The YMCA's ability to fulfill this impulse to be a partner in this regard depends very heavily on its ability to raise additional dollars.

[698] Turning now to the tax policy issues at hand let me say first that all of America's charities are not creatures of federal tax law. America had a strong tradition of private initiative for the public good long before we had a federal income tax, indeed long before we had a federal government.

[699] On the other hand, from the beginning of this century, federal tax policy has provided strong support for charities. These supported tax policies have surely had much to do with the continued growth and dynamism of the charitable sector.

[700] Our own board -- 75 of the wealthiest, most influential citizens in Los Angeles -- was in retreat with us over the weekend. I told them I was coming here and I asked them if any of them had been influenced in any way by the Tax Code to make more or larger contributions to their community. When the laughter died, they asked if I was serious that this would be considered. They said, "Of course," they had been influenced mightily to give more and more often because the Tax Code favored their participation.

[701] I've had conversations like this for 26 years with individuals about their charitable activities involving the raising of tens of millions of dollars. The story is always the same. One gentleman, who was the beneficiary of a leveraged buyout and realized a gain of appreciated assets of $5 million gave $1.5 million of that $5 million gain to charity. I asked him, "What would have happened had the laws been different or had there been no incentive in the tax codes for his participation?" He said he believes in charity. Having been raised in Germany, having been in a society where no encouragement was given for such things that he would have given some, perhaps, $200,000.

[702] Four aspects of the current law are particularly important. First, a clearly defined category of tax exempt charities; second, a broad concept of charity defined in terms of benefits to the community as a whole, rather than narrowly defined terms of relief of poverty; third, strong tax incentives for charitable giving; and finally, tax exemption for income earned from activities directly related to an organization's charitable purposes.

[703] The four key elements of current law provide clear benchmarks for evaluating the implications for charities for proposed replacements for the federal income tax.

[704] To appreciate how important it is to sustain this incentive in America, just come to the Los Angeles Y, talk to any of the thousands of kids who benefit from scholarships every year to go to summer camp, the thousands of seniors who are involved because we're able to say, "We'll turn no one away for lack of funds," to thousands of single parents who have their children in subsidized child care -- the children playing in innercity soccer teams, the runaway youth and homeless families who have transitional housing at our Hollywood Y, or any of the hundreds of at-risk teens who are served.

[705] In the past six years, we've been able to raise $81 million, $12 million in the last year. Without this support, none of these programs would have been possible. America needs its charities now as never before. This is precisely the wrong time to weaken the federal tax policy supports for charitable giving. We hope they will be increased.

[706] Thank you for your time and attention.

[707] CHAIR ARCHER: Thank you, Mr. Rosen and my gratitude to each of you for coming, many of you from a long way away, to be able to give us the benefit of your testimony.

[708] Mr. Tempel, you picked up a little bit on what I commented to the last panel and I'm positive you were out there listening.

[709] I'm curious, do you have any opinion as to why -- assuming that you're correct that things were different back in the late 20s and 30s as far as community giving was concerned and sharing. Why has that changed?

[710] MR. TEMPEL: Well, this would be opinion, although there's been some recent research by a colleague of ours who has written an article called, "Bowling Alone," who attributes much of the breakdown, recently, to television. But in fact, the community where I grew up was a very close community.

[711] As Peter Drucker said, there was a time in America when almost every person who grew up in a small community and could remember someone who grew up in a small community. As confining as that was, it was a place where you belonged, where you paid attention to others, et cetera.

[712] He says -- Drucker says, "As societies and communities became larger, people no longer had that close connection." The question is, how you can rebuild those close connections in a larger community, and for Drucker that answer is, not-for-profit organizations.

[713] He says -- it says in his book on managing nonprofits that when I talk to people in nonprofits about why they're volunteering, what they're doing, he said almost universally the response is, "Because here I make a different, here I belong."

[714] It's that kind of involvement and encouragement that we think the federal government should send a signal to in whatever it does with the tax codes and other programs because we think that it can be rebuilt by using nonprofit organizations.

[715] CHAIR ARCHER: To what -- what importance do you attach to the creation of more lavish welfare systems in the bigger cities that operated as magnets to draw people in and then they really couldn't get out? Those programs did not exist in the late 20s and early 30s.

[716] MR. TEMPEL: You're taking me into an area in which I have no expertise, so when I comment, I can't comment as a social scientist who studied those things. But again, I believe deeply that people who are in circumstances that are less than ideal who don't have hope and sometimes get hope through nonprofit organizations. That is, the quickest way to find hope for yourself is to find a way to help someone else.

[717] I mean, one of the key things you said a minute ago was that you were asked to help someone less fortunate than yourself, although you weren't in very good circumstances yourself. I think that's the key to this. That we must encourage philanthropy at every level of society. Because those people who learned to help others learned to help themselves, learned to find meaning in life, et cetera.

[718] So I think that programs that make people dependent are not programs that are very helpful to society as a whole; and again, I'm speaking as an observer of this and not as a social scientist.

[719] CHAIR ARCHER: Thank you for your input.

[720] Mr. Jacobs.

[721] MR. JACOBS: First, I should comment. Mr. Rosen, you know the chairman believes in charitable giving. He gave you an extra four minutes just now.

[722] CHAIR ARCHER: And I apologize.

[723] (Laughter.)

[724] MR. JACOBS: No, no, no, no. Your gratitude, I should thank.

[725] Of course, Chancellor Tempel, I welcome you to the committee. I spent my time at IUPUI. My nephew went through IUPUI and the law school, is doing very well. If conjoling and prayer and suggestion can have any affect, our two little boys will go to IUP. I whisper in their ears every night. Compared to Harvard, you can imagine why.

[726] Chairman Archer knows that he is among my most respected colleagues, among those I respect the most, and he knows that I count him as a dear friend as is true of Senator Lugar from Indiana, but we do part company on the sales tax.

[727] However, I was just sitting here trying to think, if the government were of a mind to substitute the federal income tax with a national sales tax, would the government be capable of -- shall we say -- subsidizing charitable giving as the present tax code does?

[728] The thing that crossed my mind was the so-called challenged grant. How do you suppose it would work if somebody gave $70 to the YMCA and the YMCA then were, under law, permitted to remit proof of that giving to the United States government which then would forward a matching $30.

[729] Has that crossed the minds of any of the members of the panel as some way you might -- let me just give you the one metaphor that occurs to me. I expect the best -- we have geothermal heat at our home in solar panels. That's okay, that's forced air. But, if you have hot water heat -- the base board heat in your home -- that little problem delivering air conditioning, you usually have to have a separate -- you have to have a set of ducts in a separate system.

[730] So here you go to sales tax -- and that's rather like the hot water heat -- how do you deliver the deduction, how do you deliver the government participation in giving; and that's what occurred to me.

[731] Does that make any sense to the panel members, first the one who could flunk our kids.

[732] MR. TEMPEL: Well, let me -- I can comment just briefly.

[733] First of all, matching gifts and challenged gifts are great techniques in fundraising; and we know that people respond to those when they can see they can enhance their impact. I don't know if this panel has given great thought to that concept. I think that in a sales tax a charitable gift incentive can be structured.

[734] If you think of gifts of philanthropy as being part of the savings plan -- that is, investing in the future of our country -- you could structure such a plan. I think Mr. Clotfelter and other economists who've studied the flat tax and the sales tax models can comment more intelligently than I can, but I want to tell you that there is -- I've had discussions recently with some college presidents in Ireland who are trying to adapt a more Americanized version of philanthropy and promote it in Ireland. In fact, in Ireland, if you make a charitable gift deduction, the organization verifies to the government that you've made that deduction and then the government sends you some money back.

[735] It's a system that has a lot of burdens in it, so -- because of all the requirements that one must go through. So, there's something at least one could look at. But I think I'll defer to others who might have a more intelligent comment on it.

[736] MR. CLOTFELTER: The Irish and English approach that you described is essentially the same -- works the same as our deduction.

[737] As far as the -- could you structure an incentive similar to our deduction under a sales or value added tax, I believe even the staff publication that you've got for these hearings that I just looked at a little while ago outlines the fact that a VAT with an exemption appropriately structured for nonprofit organizations would give you a price effect that would be very similar to the current deduction.

[738] MR. JACOBS: I think my time has expired, essentially.

[739] CHAIR ARCHER: Mr. McCrery.

[740] MR. McCRERY: Thank you, Mr. Chairman.

[741] Mr. Clotfelter, I was intrigued by one thing that you said in your testimony. I want to explore it a little bit.

[742] You said that while tax policy generally won't determine whether someone gives to charity, it can affect how much people give. Do you recall saying that?

[743] MR. CLOTFELTER: Yes.

[744] MR. McCRERY: And, I'm trying to determine whether you think that tax policy is a marginal consideration in the determination in someone's mind to give to charity? And, if you think that marginal effect can be overcome by a tax policy that may not favor charitable giving, but encourages greater economic growth, ends up giving people more disposable income, have you looked at that or considered that?

[745] MR. CLOTFELTER: Let me just answer by analogy. Imagine you were trying to think about the demand for bananas at your local grocery store. Would coupons that give you a 30 percent reduction on the price of bananas, would that be a marginal effect or not and compare that to the effect of giving all the customers more income.

[746] More income would probably -- because bananas are what we call a normal good -- lead them to consume more of it. So then it just turns out to be an empirical question: How much do these price effects affect the demand for bananas?

[747] So economists really don't have much to say about something like whether it's a marginal consideration, they look at what's the empirical effect.

[748] So, the research that I'm familiar with says that charitable giving, like bananas, is somewhat responsive to price as well as income, and both of those would have an impact.

[749] MR. McCRERY: So, I think what you're telling us is, if we could construct a tax policy that did not give preference to charitable giving; but on the other hand left more money in the pockets of people in the way of disposable income, you don't know what the outcome would be as far as the level of charitable giving in the country?

[750] MR. CLOTFELTER: One could imagine a tax system that increased it purely through income effects, but it's hard to see on a piece of paper how the federal government's budget would be balanced in that way. Because we were doing calculations that were under a revenue neutral assumption.

[751] So, it's conceivable, but you would have that revenue problem to deal with.

[752] MR. McCRERY: Sure, that's the problem we have as policymakers. We can hire the smartest economists in the world, but they all have to make assumptions to reach their conclusions and we don't know if those assumptions are good assumptions or faulty assumptions. So, we're left with tough decisions sometimes.

[753] I think all of us on this committee want to encourage charitable contributions and make them ourselves; but we also have to think about what's in the best long-term interest of the economy as a whole; and know if we can improve the economic conditions on the whole, we probably improve the level of charitable giving in this country, if we are assuming -- if we're making the proper assumption with respect to the character of the American people. Again, we don't know if we're correct in that, but those are the decisions we have to make.

[754] Thank you all for your testimony.

[755] CHAIR ARCHER: Mr. Laughlin.

[756] MR. LAUGHLIN: Thank you, Mr. Chairman. I apologize for missing most of your testimony; but if you've answered it, just tell me you've answered it.

[757] I've heard some say that taking away the charitable deduction from a tax view point would not substantially reduce charitable giving. Do any of you agree, disagree? As I glanced through your testimony, you all seem to be saying you need the charitable deduction from taxes and I just wanted to see what response you had to the several who have said to me that it would not substantially reduce charitable giving.

[758] MR. CLOTFELTER: I think I'd disagree. If substantially -- not substantially would include 30 percent or 20 percent, I would say that getting rid of the deduction probably would have a noticeable affect on charitable giving. That's what the research that economists have done using a variety of different data sets and periods have found.

[759] MR. ROSEN: My research is simply talking with donors of the 26 years and having a family of 35,000 donors, annually, in the YMCA. I am unaware of any significant donor who is unaware of the tax benefits and the costs of making contributions, and who does not take those into consideration in making gifts; or who has not made a larger gift because the Tax Code made it possible.

[760] MR. LAUGHLIN: And, it is your opinion, then, Mr. Rosen that if the tax benefit were removed, those donors -- many of them -- would evaporate on you?

[761] MR. ROSEN: They would still be there, but at much lower levels. I don't think the Tax Code prevents people from giving one way or the other, but it certainly increases -- influences the size of the gift substantially.

[762] MR. LAUGHLIN: Anybody else?

[763] MR. TEMPEL: Well, we do know -- we do have the evidence that when the marginal tax rates were changed that giving among donors of significant wealth dropped, the average gift dropped.

[764] For example, the taxpayers with incomes of $1 million or more, between 1980 and 1993, their average gift dropped from $207,000 to $108,000, which is one of the studies we have to use to talk about what gift -- what impact the cost of giving has on giving.

[765] It is our experience as fundraisers on an individual case- by- case basis that major gift donors talked to us about these tax structures when they make those large gifts; but this is fairly conclusive evidence that the cost of giving has an impact, especially on large gifts.

[766] MR. LAUGHLIN: And I noticed in a lot of the written proposal statements that you've submitted that there's discussion of the various tax proposals out there.

[767] Mr. Tempel, do you feel that charitable giving is enhanced or stimulated more under one of the proposals rather than -- which proposal, if any, do you think charitable giving is enhanced, other than staying with the current system?

[768] MR. TEMPEL: Well, I would say that Mr. Archer's proposal, the 91 percent tax rate, would help us out a great deal.

[769] (Laughter.)

[770] MR. TEMPEL: But the -- in fairness, I think what we want to search for is balance. That is, under a flat tax system, for example, we think there will be an impact. Studies by Steinberg and other economists -- I'm sure Dr. Clotfelter would say the same thing, that the cost of giving has an impact on giving.

[771] So, as the rates drop today, we see -- unlike the situation that might have around in the late 1920s -- that giving will be challenged. So, if there is a way, for example, even to create a combination of tax credits and tax deductions to stimulate larger gifts, we think that will -- as Mr. Steinberg, an economist on our campus proposes -- would be very helpful to charitable giving.

[772] MR. LAUGHLIN: Thank you very much, Mr. Chairman.

[773] CHAIR ARCHER: Let me file an immediate disclaimer that I'm not proposing the 91 percent income tax rate.

[774] (Laughter.)

[775] CHAIR ARCHER: Thank you very much all of you for the testimony that you've given to us.

[776] MR. TEMPEL: Could I take a privilege to thank my Congressman from Indianapolis for being here for this hearing.

[777] CHAIR ARCHER: Certainly, sir.

[778] You've helped us move along this road. It's going to be a long road, a major undertaking, but I hope we can find the right answer to benefit everybody.

[779] Thank you very much.

[780] (Whereupon, at 3:50 p.m., the proceedings were adjourned.)